Money Morning | 28 June, 2011
IN THIS ISSUE:
• How to profit even if Ben Bernanke turns his back on QE3
• Three “below-the-radar” companies offering huge gains over the next 3 to 5 years
• A Financial Insider reveals how you could beat the market by 50% in just a few trades a month
From Gary Booysen, analyst, Stockmarket Sleuth
It looks like 27,000 on the Alsi Top40 has become a critical level for investors. A dismal June has seen the local market slide around 7% - and the month still isn’t over!
The consensus among fund managers is that this is a fantastic opportunity to pick up stock cheap!
But when buying into a falling market, the question is, how much pain can you take before the market turns?
Investors going long are starting to get squeezed as they wait for the bounce. No doubt those with true grit will reap the benefits in due course. But in the meantime it becomes more and more difficult to maintain a long position.
Phrases like “don’t catch a falling knife” start to whirl around the subconscious. Of course, if we see the Fed step in with QE3 the party is going to really kick into gear. But judging from the Fed meeting last week there could be a little more pain before the good times start.
But just because the equity market is suffering doesn’t mean there aren’t still ways to profit. Today John Stepek looks at how to play the delay (or possible non-existence) of a QE3 rescue package…
From John Stepek, editor of MoneyWeek, in London
Quantitative easing (QE – money printing) is the main influence on markets right now.
Don’t believe me? Then just look at what happened last week. Investors forgot about the drama of the eurozone, and spent most of their time holding their breath ahead of the Federal Reserve’s latest interest rate decision.
Vague hopes that Fed chief Ben Bernanke would hint at a third batch of QE saw the dollar dip, stocks rise and gold surge. Then, when ‘helicopter Ben’ stayed firmly on the launch pad, stocks ended the day down, with the Dow Jones sliding 80 points or so.
So if hopes and fears for QE3 are what’s driving markets right now, when – if ever – can we expect it to arrive?
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Investors are trying to second-guess the Fed
It’s not healthy to spend too much time watching the markets. Pay attention to every news flash and price surge, and pretty soon you’ll find yourself a panicky, over-trading mess.
But occasionally, it can be very informative to just sit back and watch how the market behaves. And last week was one of those weeks.
Fed chief Ben Bernanke was due to speak late after our market closed. The day’s trade was subdued early on, as investors remained nervous about the eurozone situation.
But as the day wore on, you could feel the tone changing. The dollar started to slip. Stocks crept higher. Gold surged. You could practically hear the wheels turning in investors’ minds.
“What if the Fed announces QE3? I don’t want to be short if that happens. Sure QE2 is just ending, but he might announce it. After all, US jobless figures have been pretty duff recently. And everyone knows Bernanke wants a weak dollar…
“And just look at the state of the eurozone. In fact, how can he NOT announce QE3? I’d better pile in!”
Markets are the best way of setting prices that we’ve found so far. But they’re clearly not perfect, regardless of what the theory says. And forcing all the participants to second-guess the actions of a monster player with limitless amounts of money and uncertain motivations makes them even less efficient.
In any case, the Fed disappointed investors. To sum up, Bernanke said that the economy was growing more slowly than they’d expected. He said this was partly down to temporary factors, but that growth in 2012 would come in at 3.3-3.7%, rather than an earlier forecast for 3.5-4.2%.
But at the same time – and I suspect this is what really rattled markets – the Fed dropped its reference to inflation being “subdued”. It couldn’t very well keep it. Even core inflation (which ignores things like food and energy) is rising at an annualised rate of 2.5%. If Bernanke can’t point to deflation as a threat, then it becomes a lot harder to justify another batch of QE.
Now let’s make something clear here. It’s not as if the Fed is planning to tighten monetary policy. There was no hint that the US central bank would raise interest rates. It’s not even reversing QE: the plan is that when existing bond holdings mature, it will use the proceeds to buy new ones.
But for now, there’s no plan to do more QE. And that’s enough to get investors frightened of what will happen when the Fed goes away.
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We’d be better off without QE3
So what happens next? I’ve been talking to various fund managers recently, and the general consensus around QE3 is that “we’ll get it if we need it”.
I’m sure they’re right. But it all comes down to what that word “need” means. As one Fed member, Charles Plosser, noted last month, “the hurdle rate for doing more [QE] is very high”. In other words, it’s going to take more than a mild wobble in the market to make QE3 politically palatable.
However, contrary to what investors might believe, it may well be better for us all if QE3 stays on the shelf. There still isn’t full agreement on exactly how QE works. But looking at what’s happened since it launched, it helps to drive up the price of financial assets, including commodities, while doing little to free up bank lending.
So it drives up the cost of living, but doesn’t seem to be making credit conditions much easier: certainly not for the man in the street at least.
The rising cost of living is why the big threat to everyone right now is not deflation or rampant, overheated inflation: the real threat is stagflation. With the cost of essentials rising at a time when wages are stagnant, the spending power of credit-starved consumers is being crushed.
If we could get commodity prices down without decimating economic activity, it would be good news for the ‘real’ economy, even if it meant putting up with a bit of a bumpy landing for stock markets. Maybe Ben Bernanke realises that.
On top of this, with China already tightening monetary policy (indeed, the cost of interbank lending has hit its highest in three years), the US doesn’t have quite as much incentive to indulge in a currency war. If there isn’t the same need to pursue a weak dollar policy, that’s another reason why QE3 may not arrive as quickly as markets believe.
What a stronger dollar means for you
What does all this mean? In short, I think we’re going to see the dollar get stronger for much of this year.
The most obvious global impact is that commodity prices will be lower. We’ve already mentioned that taking profits on miners is probably a good idea. For sterling investors, it is starting to look as though the pound will have a very tough year. The Bank of England has no plan to raise interest rates and investors are starting to realise this. So having some US dollar exposure in your portfolio might be a good idea.
Until next time,