Monday, August 22, 2011

What's the Point of More QE?

Yahoo Daily Ticker had an interesting interview with Edward Dempsey, CIO of Pension Partners, asking what's the point of more QE?:

This week's financial and economic calendar culminates Friday with Federal Reserve Chairman Ben Bernanke's policy speech at the Fed's annual summer getaway in Jackson Hole, Wy.

Will he or won't he announce another round of quantitative easing? That's the big issue facing financial markets.

It was at this same conference last August that Bernanke cued in the markets about the second round of quantitative easing, which resulted in the Fed buying $600 billion of Treasury bonds between November 2010 and June of this year. In the first round of QE between Dec. 2008 and March 2010 - the Fed bought $1.7 trillion of debt, mostly mortgage securities.

I'm sure the Feds have "QE3 through 30 queued up and ready," says Edward Dempsey chief investment officer at Pension Partners. "However, I don't know how effective it'll be."

Though markets ticked higher after the Fed's August 9 announcement that it would keep rates "exceptionally" low through mid-2013, it's done little to quell the volatility and nerves.

Traders and 401(k)s may benefit from more Fed action as it may generate asset reflation, but Dempsey says QE3 is unlikely to relieve stress in the real economy, citing the impact of two QEs to date. "It has not done anything for house prices, it has not done anything for wage growth. It hasn't done anything for employment."

In fact, Dempsey is unclear if it's benefited anyone. "We are approaching zero yield," he says. "It's devastating on retirees, it's devastating on pensions and endowments" - his main focus of investing. Many pundits, including Jim Cramer, have been pushing dividend-yielding blue chips as a wise investment for those looking for income in their portfolio.

But "I would be very uncomfortable placing my capital at risk for a 2 or 3% yield," Dempsey says. As discussed in this previous clip, he's worried the 'summer crash' isn't over just yet.

In the meantime, savers will continue to be penalized until hopefully, the economy recovers to a point the Fed feels comfortable raising rates to forgotten "normal" levels of 1% or higher.

I've already stated that the Fed doesn't care about anything else but the banking system and reintroducing mild inflation into the global economic system. Quantitative easing is already pushing food and energy prices higher everywhere, including in emerging markets. And now the Fed has given a green light to big banks to trade like crazy for the next two years. Unfortunately, the volatility in the stock market is spooking homebuyers, pushing the housing recovery further away.

Last week, Steven Johnson of Reuters asked, Fed may have bullets left, but are they blanks?:

When Federal Reserve Chairman Ben Bernanke takes the podium next week at the central bank's annual meeting in Jackson Hole, Wyoming, his sense of deja vu may be overwhelming.

Stocks have been giving up gains won after last year's speech, when Bernanke hinted at plans to pump more money into the financial system. Oil prices are higher and there's been little improvement in the job market. Bond yields are down, though, because the economic outlook has deteriorated.

It's almost as if QE2, the Fed's $600 billion bond-buying program first mentioned at last year's meeting and designed to boost the struggling economy, never happened.

That's not to say investors doubt the central bank's resolve to act again if the U.S. economy keeps losing steam. Last week, it surprised markets with an unprecedented pledge to hold interest rates near zero until at least 2013.

But given questions about the efficacy of monetary stimulus to date and a growing political backlash against the Fed's policies, investors expect the U.S. central bank to keep its powder dry at this year's Jackson Hole symposium from Aug. 25-27.

"The Fed already shocked the world when it indicated its ultra-low interest rate policy would remain in place until 2013," said Fred Dickson, strategist at D.A. Davidson & Co in Lake Oswego, Oregon. "That telegraphed the economy is going to stay weak. But monetary and fiscal policies haven't worked very well, so I don't expect we'll get a QE3 announcement. That would really catch everybody by surprise."

It's not that the central bank doesn't have a few tricks left up its sleeve. Bernanke has previously detailed what he could do next. This includes buying long-dated Treasuries to push down long-term rates and cutting interest on bank deposits held at the Fed to encourage more lending.

Still, there's the problem of ever diminishing returns. The benchmark S&P 500 index rallied more than 4 percent when the Fed on Aug. 9 said it would keep rates low into 2013, but fell more than 4 percent the next day. At around 1,200, the index is off its Aug. 8 low but trading remains volatile.

Atlanta Fed President Dennis Lockhart has said the central bank could buy more long-term bonds to lengthen the duration of its portfolio, which would flatten the yield curve and allow homeowners to refinance at lower interest rates.

But with rates already low, the impact may be muted.

What's more, investors said lower 30-year bond yields could actually complicate life for insurance companies that have to match liabilities and assets.


Then there's the limited impact the Fed's quantitative easing, or QE, has had on the broader economy, which ground to a halt in the second quarter and, some fear, is flirting with a slide back into recession.

Economists polled by Reuters now expect the economy to grow at just a 1.7 percent rate in 2011, well below the Fed's June forecasts of 2.7 to 2.9 percent.

Including QE2, which ended in June, the Fed has spent some $2.3 trillion in recent years to prevent a slide into deflation, more than tripling its balance sheet in the process.

"On one hand, QE2 added to the U.S. market. On the other, a lot of the liquidity fled and went into emerging markets and commodities, and those commodities, including oil, went higher in price," said Ashish Shah, head of global credit at AllianceBernstein, with $216 billion in fixed-income assets. "So you actually robbed consumers of purchasing power."

That has put the Fed in the line of fire of some politicians and voters -- so much so that some investors fear the growing politicization of Fed policy could curb its independence.

Texas Governor Rick Perry, a Republican candidate for president, even said he would consider it "treasonous" if Bernanke "prints more money between now and the election" in 2012.

William Larkin, fixed income portfolio manager at Cabot Money Management, dismissed Perry's remarks as "crazy talk," but did say the Fed faced increased political hurdles.

"The Fed is going to face a lot of push back," he said. "Keeping rates low has caused talk of financial repression --- stealing from savers and giving to debtors."

A weaker dollar, partly the result of the Fed's easing, also complicates things. While it in theory helps exports, it also makes imported goods more costly, putting more pressure on consumers. Against major currencies, the dollar is 11 percent weaker since the August 2010 Jackson Hole meeting.

"The Fed is being viewed as a political rather than financial actor, so their policy responses may have to be political as well as economic," said Boris Schlossberg, head of research at GFT Forex. "As they lose their credibility among a certain segment of the population, that whittles away the kind of independence they used to have."

Support for more easing isn't universal within the central bank, either. Dallas Fed President Richard Fisher, one of three policymakers who voted against keeping interest rates low until 2013, blamed "fiscal misfeasance in Washington" for the economy's woes.


None of this makes investing any more straightforward, money managers say. While stocks still look more enticing than low-yielding Treasuries, many portfolio managers have grown more defensive given the worsening economic outlook.

Dickson said he recommends clients increase cash and metals allocations just to be safe. But he still favors stocks over bonds, particularly multinational stocks that offer dividend yields above the 10-year Treasury.

He said a D.A. Davidson & Co portfolio of such stocks has held up better than the S&P, shedding about half as much as the broader market between mid-July and Aug. 8.

Another option for equities investors is high-yield corporate bonds that offer comparable returns but "half the volatility" of stocks, Shah said, noting U.S. corporations are sitting on piles of cash.

"But for people who want to preserve capital, there aren't a lot of choices," he said. "You're going to earn zero here."

There may be reason to hope that the Fed won't need to act again. The central bank's latest senior loan officer survey showed some easing in lending conditions, particularly for commercial and industrial loans to businesses.

If the trend persists, that could encourage more hiring.

Should things take a turn for the worse, though, investors had better bet on another round of QE, said Michael Cheah, senior portfolio manager at SunAmerica Asset Management in Jersey City, with $1.5 billion under management.

With inflation low and wage growth stagnant, he said the Fed has the leeway to pour more money into the system. That would boost stocks at the expense of bonds and stoke demand for higher-yielding currencies over the dollar.

"I think quantitative easing is only creating the illusion of prosperity but my job is to trade that illusion," he said. "That makes me bullish stocks."

Indeed, QE is creating the "illusion of prosperity," but it's bolstering trading revenues at the big banks, allowing them to essentially profit for free, and buying them time to shore up their balance sheets. That's what the Fed is gambling on, by bolstering banks' trading revenues, and introducing mild inflation into the economic system, they will be able to avoid a Japanese-style deflationary episode. And for all the critics of QE, think about this: what would have happened if the Fed did nothing and Washington remained polarized with diametrically opposed political views on the debt ceiling? It would have been a disaster. Like it or not, QE might have saved the system from total collapse.

But QE is creating more volatility, allowing high frequency traders to make a killing while retail and institutional players scramble for yield. In these volatile markets, you need to swing trade. Forget buy & hold, you will get killed. I have been spying on elite funds, watching what they've been busy buying and selling. Many elite funds have gotten killed in the latest market route but there are interesting stocks on my radar: RIMM, A, GLW, FSLR, JDSU, JNPR, ORCL, SYMC, EMC, C, BAC, MDT, MOS, SLV, LDK, YGE, are just a few of the symbols I'm tracking. But there is no rush to buy stocks yet.

Below, watch the clips I embedded with Edward Dempsey. He thinks we're going to head lower from here and he's still bullish on gold. I also embedded an interview with Axel Merk, founder of Merk Investments and manager of the Merk Hard Currency Fund, who says not only is it unwise for the Fed to commit to another round of QE, it's also unnecessary. "The Federal Reserve has managed to move the markets with words rather than action," he says, citing the Fed's announcement on August 9 to keep rates exceptionally low through mid-2013 and the drop in interest rates along the yield curve that followed. "Short-term cost of borrowing has pretty much gone to zero," he notes. "That is something that previously only been done through the purchase of securities." Excess printing by the Fed is why Mr. Merk is bullish on the euro.

My take: If the Fed does nothing, markets might initially sell off but I would be buying that dip hard, especially in financials and high beta stocks. There is plenty of liquidity to drive risk assets much higher. Stay tuned.

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