(QE = Quantitative Easing = Money Printing!)
Executive Summary: The much-anticipated Federal Reserve update a few weeks ago resulted in – to our surprise, a lot more ‘action’ than we thought would happen. As a result, we continue to be pleased with how our investment portfolio is performing in recent months and we’re even more confident that we have the right mix going forward.
The Details: So what actually happened and what is QE3? Here are the salient facts:
- The creation of $40 billion a month out of thin air to purchase agency mortgage-backed securities at artificially low interest rates – some more recent estimates have revised and increased this number to over $80 billion;
- The continuation of “Twist 2” and the shifting of Federal Reserve holdings of US Treasury Bonds into longer-term bonds;
- Combined purchases of long-term securities between QE3 & Twist 2 of approximately $85 billion per month through the end of the year; that is more than ONE TRILLION per year of additional money-printing.
- Quantitative easing without any pre-defined limit, meaning an open-ended commitment to keep purchasing securities at whatever level is judged necessary until the labor market improves “substantially”;
- The potential purchase of additional assets and the deployment of other policy tools as needed;
- An extension of the 0.0% to 0.25% target range for the Fed Funds rate until at least mid 2015.
This is a very significant move – please take extra special note of the ‘open-ended’ commitments they refer to. It’s no wonder this move is now referred to as “QE (money printing) to infinity”!
So what are the consequences of these central bank actions?
First is the starvation of savers. That is simply what zero-bound interest rates do.
Second is the levitation of prices (inflation) outside the US. They are essentially ‘exporting’ inflation. This is especially true for countries like Hong Kong who have a fixed exchange rate with the USD – it’s a direct negative impact to them. This reduces the competitiveness of these emerging economies and well, frankly, it fans the flames of geopolitical risk.
Bernanke has essentially said ‘we are learning by doing;’ further supporting our view that this really is just one giant experiment. We’ve never seen such bold moves by the currency that holds the ‘reserve’ status in the world and yet this experiment really has been going on since 1971 when the USD was officially removed from the gold standard and exchangeability was revoked.
The last consequence we wish to outline today is how zero-bound interest rates and the resulting stampede for yield clouds the true risk of investments (like bonds, for example) due to the sheer demand and resulting price appreciation. High-yield bonds are a current example… remember, high-yield is another term for ‘junk bonds’ and yet the prices are reflecting much higher grade issuers due to the insatiable demand for yield. The bond market as a whole doesn’t signal reality right now, in our opinion. (That said, please recall our and its role in our model portfolios.)
So we must continue to look for a higher margin of safety in the investments we choose. There are undervalued companies with sound balance sheets out there. They’re difficult to find, in our opinion, but we continue to look very carefully. Remember, equity investments can fare well in moderately high inflation (quantitatively eased) environments; not extreme hyper-inflation, but moderate to high. So they can be an effective hedge and sustainer of purchasing power. We also continue to see value in gold and silver bullion – they remain an effective barometer for the macroeconomic outlook and for continued currency debasement.
Please refer to– we think you’ll find it a valuable read.
QE to infinity further supports our hard assets theme we’ve held for over four years now. Our results are starting to show the merits in this view again:
- Over the last month, the FVAM Balanced Model portfolio rose 3.4%.
- The last six months have seen a resurgence of over 6.4% bringing the rolling 1-year return back into positive territory at 2.8%.
Given our risk-averse posture, we’re quite pleased with this.
(As at 25-SEP-2012 and please remember individual results will differ).
As always we truly thank you for your loyalty and continued support.