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Growth, Value, QE Forever

09/17/12 09:08:27 AM
by Billy Williams

Fed chief Ben Bernanke made a surprise announcement that QE3 will go into effect, which can have massive repercussions for you and the market -- are you ready?

Security:   SPX, GLD
Position:   Buy

The stock market reacted positively at the Federal Reserve's surprise, and controversial, announcement at implementing another round of quantitative easing, dubbed QE3, where the Fed will have an open-ended policy of buying up mortgage-backed securities (MBS) with the goal of keeping long-term rates between 0% and 1/4% to mid-2015. The Fed's committee made a statement that they will buy MBS up to $40 billion a month with the intention of putting downward pressure on long-term rates to support the mortgage markets and, hopefully, to improve the stubborn unemployment numbers in the US that have remained just above 8%.

To completely understand the significance of the today's announcement on the part of the Fed, you have to understand what the costs are and the ripple effect that will be felt as a result that led up to this latest round of Quantitative Easing. First, the Federal Reserve does not buy these securities from cash that it has on deposit like most commercial banks do, but instead, they print the money out of thin air, which adds to the net currency base's supply and, as a consequence, devalues the money that is currently in circulation.

Add to that, the money that was printed out of thin air to buy securities is paid back to the Fed with interest, increasing the cost of funds to the American taxpayer. All of this is done in the hopes of increasing jobs and lowering the unemployment rate at the same time, but at a cost. See Figures 1 and 2.

FIGURE 1: SPX. The SPX surged over 23 points on higher volume as Bernanke made the announcement for QE3, but will it last? And how do you play it profitably?
Graphic provided by:
In Jacksonhole, WY, Fed chief Ben Bernanke announced that the first two rounds of quantitative easing had led to the creation of two million jobs. First, QE1 cost the American taxpayer around $1.7 trillion while QE2 cost $600 billion for a total of $2.7 trillion. Using Bernanke's own math, each job created by QE has cost the Fed $1,150,000. Now, according to the National Average Wage Index, the average salary is $41,673.

This means, in investment terms, that each job investment on the part of the Fed is trading at a multiple of 27.5, a pretty high P/E for any stock in this current economic climate.

If you're starting to think that something is wrong with this picture, then you might understand how to play the unfolding macro-view of what is in store for the US, and the world at large, particularly in Europe.

FIGURE 2: GLD. Another round of QE means more money being printed, and that makes gold and silver the best hedge to retain buying power as the dollar trends lower. GLD traded higher as investors and traders hedged their risk with precious metals in light of that fact.
Graphic provided by:
The Fed is putting its cards on the table in that they are going keep cheap money around for a least the next 2-1/2 to three years in the hopes that the economic engine will kickstart and get the US out of its current mess. Cheap money is really the only card that the Fed has to play at this stage, and it will be QE Forever till they see some improvement in the job market, and human nature being what it is, they will probably keep doing QE even with job improvement. Why? Because more jobs mean more consumers, and with more consumption, the consumption-based US economy will be running at full throttle again.

But as you can tell, the Fed is lousy at creating jobs, if their numbers are to be believed.

So how do you play it? QE3 and cheap money are giving the stock market a lift, so in the short term, buy breakouts and trade intelligently till it runs its course. In the next couple of years, the party will be over and the hangover will begin as price ultimately declines and the hunt for strong value companies with distinct durable competitive advantages will present themselves.

In addition, look at diversification into gold and silver again as they act as a hedge against the rampant printing by the Fed and retain their worth compared to the dollar. Mining companies will soon be in vogue as strength pours into those stocks as institutional investors build their portfolios around this sector for the coming boom.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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