QE3 and the Kitchen Sink

By David B. Armstrong, CFA | Sep 17, 2012 | Weekly Market Commentary

It looks like the Fed decided on a new monetary policy that throws everything INCLUDING the kitchen sink at stimulating the economy and bringing down the unemployment rate.  I’m sure that someone decided “Kitchen Sink 1” was not “fin-glish-y” enough to pass muster as a name to be captured in history, textbooks or upon gravestones so someone floated “QE3” and it flew.

We knew that the markets were anticipating the Fed would act, but the degree to which they decided to increase its balance sheet (creating new money) and buying bonds was met with huge enthusiasm by traders. For that matter, the people who think they are investors (but are really traders) should see my most recent U.S. News and World Report column.

Oh, and it wasn’t just stocks, which once again finished the week at a multi-year high. Oil, gold and myriad other commodities gained on the news as well, while the dollar continued to slip.

In text talk – btdubs, that’s what you would expect to happen when people pile back on buying the risky assets.  Cool people with awesome cufflinks call this the “risk-on trade”.

Here’s how markets finished up the week.

The Details of the Kitchen Sink

The Fed said it will buy $40 billion in mortgage-backed securities every month until a significant improvement in the labor market is realized. The hope is that the housing market, now actually showing some life, will rebound faster while keeping mortgage rates low or even lower.  There’s no doubt about it – the economy has a lot to do with housing and cars.

$40 billion seems like a lot unless you are an elected official, but the reality is that it’s not as large as the monthly outlay from Quantitative Easing 2, or QE2, (which could eventually be referred to as “the bathroom sink”). See, back in 2010-2011, QE2 amounted to $600 billion in Treasury bond purchases over eight months. That comes out to just about $75 billion each month.  The difference now is that QE3 has no set end date.  Hence “kitchen sink.”

In its statement, the Fed said “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

So it looks to me like the Fed will continue purchasing bonds until it sees substantial improvement and if it doesn’t happen, they will employ even more firepower.

If I drew funny cartoons for a living, I’d draw one of Chairman Bernanke standing at a grill squeezing a stream of lighter fluid from a bottle that said QE3 onto the word “economy” smoldering on the grill top…and fire working its way back up the stream.  But I can’t draw – so there’s that.

Our Thoughts

We still like an over-allocation to small and mid-cap indices vs. the large caps and remain in the growth over value camp as well.  Our fondness for economically sensitive sectors has not changed since the end of 2008.  Specifically, we still like the Tech and Consumer Discretionary sectors.

Our position remains that the U.S will not see a double dip recession so long as housing does not experience another downturn, and our domestic economy will continue to grow in the most modest of ways.  Much like 2010 and 2011, we could see a slightly weakening or sideways markets giving way to improvement after the election.  Given that a little weakening or sideways action would take place from a now +16% YTD number on the S&P 500 suggests to us that the overall YTD return should be much better than people may think.

Btdubs – have you seen the YTD number on the indices in the above chart???  Seriously, does it feel like a year in which the S&P 500 is up over 16%!?

Most INVESTORS should be pretty happy right about now.

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Stock investing involves risk including loss of principal. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries, and widely held by individuals and institutional investors. The Standard & Poor’s 500 Stock Index (S&P 500) is an unmanaged capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The prices of small and mid-cap stocks are generally more volatile than large cap stocks. The NASDAQ Composite Index measures all domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index. The Russell 2000 Small Stock Index is an unmanaged index generally representative of the 2000 smallest companies in the Russell 3000 Index. The Russell 2000 is an unmanaged index generally comprised of companies with lower price-to-book ratios and lower forecasted growth values.  The 2, 10 and 30 year Treasury is simply the yield at the close of the day.

⁽¹⁾      West Texas Intermediate crude spot price is as of end of week.

⁽²⁾      London Bullion Market Association; gold fixing pricing at 3 p.m. London time.