Broker Check

To QE or not to QE

Mitchell O. Goldberg
  • Written by Mitchell O. Goldberg
  • ClientFirst Strategy, Inc.
  • July 2, 2013
  • For immediate distribution

To QE or not to QE: All you need to know in just 2 questions!

This is not another dissertation about QE and Tapering; we're past that already.

Here goes:

  1. Are rising rates a death knell for stocks?
  2. At what level do interest rates need to go to attract investors?

Short answer to the first question would be no. Rates would not have been so low, my opinion (but I'm right and I'm pretty confident that you agree), had it not been for FED intervention. So the air pocket from 1.6% on the 10 year to 2.6% was not based on inflation expectations, the least desired cause for rising rates. This is why the major stock averages have held up near peak levels. And about the recent dip stocks just had? Major non-event. The two sectors that are acutely affected by interest rates, autos and home builders, have just come out of a financial nuclear winter that lasted for about 5 years. Volatility aside, these sectors had more in their favor than just low interest rates. They have shortages, replacement cycles, and demographics strongly in their favor and those factors are more than strong enough to overcome the rise in rates thus far and I believe that will remain the case when rates move higher.

Long answer depends on how quickly inflation expectations climb. But with slowing growth in China, commodities based economies (primarily Brazil, Australia, Russia, and Canada) are seeing domestic GDP expectations coming down. Simply put, commodities prices are in retreat and that keeps a lid on inflation globally. Bad for commodity producing nations, but good for commodity consuming nations. What about all that money printing by the FED? Well, it is time for the inflation hawks to realize that we are much closer to the end of the QE's than the beginning and inflation expectations are still low. Then again, to understand why money printing hasn't caused inflation to surge is to understand that the new money never actually made it into the real economy; it stayed mostly in bank balance sheets. Nice try by the gold bugs by attempting to scare investors by using the Weimer Republic as a scare tactic, by the way. But in that case, the banking system wasn't nearly as advanced as ours is today and the cash back then went directly into the populace's hands. The bottom line on inflation expectations is that for now, it remains very low. The strategy here is that while we are in this period of change, and change is often accompanied with volatility, is to realize that your winners will be determined by your purchase price and not on near term sale prices. Or, instead of buying high to sell higher, go with buying on dips and scaling out when potential investment upside is realized.

Short answer to the second question is that rates as of this writing have stabilized. If not an overwhelming number of buyers are out in force, then we could at least say that the sellers have, for the time being, exhausted themselves. Buyers in the form of pension plans, retirees, asset allocators and others still need to own fixed income, so the level that would attract buyers is always here. Again, this is my short answer.

Long answer is that interest rates are going higher. Eventually, that is. But it is the calm time frames between the episodes of bond market volatility that buyers will enter the market. This brief writing doesn't take into account potential changes in portfolio duration, yield curve positioning, and shortening of maturities, but this is beyond what is necessary to answer the above two questions. Investors who see a particular yield and a particular credit grade that meets their unique needs will buy; that's my answer. And so many investors are so hungry for higher yield, that today's rates may actually be too tempting to pass up after fixed income investors suffered through their own nuclear winter of ultra-low yields.

Summary: The wind down of the 3 QE's and the ZIRP (Zero Interest Rate Policy) will go on for years. And in the world of finance, a year these days is a long time. 3 to 5 years, which is what I expect? That's an eternity. Instead of "QE Forever", we could say "Wind Down Forever". But as a group, we investors may be accused of tunnel vision by focusing exclusively on FED tapering. Really, what we need to focus on is that the global relationship between commodities producers and consumption led economies has become mutually exclusive. The operative words here are "consumer led economies" and nowhere does that description fit better than the United States. To QE or not to QE be damned; domestic equities is the place to be.