Financial Watch: Good things come in 3’s??

Depending upon how your mind warps reality:

1)      Quantitative Easing has no positive economic effect and never will.  It is all smoke and mirrors, and it will end badly either through deflation, or hyperinflation, or both.

Or

2)      QE has lowered interest rates by a few basis points and generated a gain of about 2+ million jobs over what otherwise would have happened. Stock price increases reflected the improved economic prospects from the program, and also created a virtuous cycle of confidence and wealth effects.

That’s kind of it in a nutshell.  A week after the European Central Bank introduced its Outright Monetary Transactions (OMT) program, the Federal Reserve unveiled its newest version of monetary easing or QE3 as the media have begun to call it.  This time around it’s an open ended program to buy mortgage bonds, plus an extension of the previous Operation Twist to suppress short term rates out to mid-2015.  Its immediate byproduct helped risk asset extend their rally for a second week.

The Dow Industrials, S&P 500, NASDAQ, and Russell 2000 all recorded new 52 week highs and eleven of twelve major foreign indexes joined in the global equity rally.  Only the Shanghai Composite didn’t participate, as investors realized the 1 Trillion Dollar Chinese infrastructure spending program had begun with initiatives that were already underway in that economy and there really wasn’t any cause for a victory lap.  Like having your own party, the day after everyone attended the bigger party; not too many showed up and those that did were hung over.

U.S. Treasury yields continued to move with the 30 year seeing 3.1%, the 10 year settling at 1.88% and the 5 year cresting at 73 basis points.  Yields on investment grade corporate and municipal bonds charted alongside Treasuries higher, but junk bonds were bid much higher.  TIPS on the other hand saw yields fall, as bond investors sought inflation protection.  To be clear, inflation anticipation on a macro level is the 800 pound gorilla in the room, but given the surge in commodity prices, bond buyers are being realistic in seeking protection.   Gold and silver continued their torrid upward advance, with gold adding another 2% and silver more than 3%.  Copper advanced more than 4.6%.  Crude oil briefly topped $100 before settling at $99 at the close on Friday.  Natural gas couldn’t hold above $3. The grains remained mostly flat while the softs began to show some momentum and strength, with sugar coming off a bottom and coffee making an 11% move.  So much for the quiet but effective stimulus of lower prices that actual consumers enjoyed over the summer.  Unmistakably, Fed policy and a declining U.S. dollar are bullish for the commodities and in the case of oil; unrest in the Middle East is helping to raise prices measurably.

I remain optimistic.  The current mantra of “The trend is your Friend” or “don’t fight the Fed” (or the ECB for the matter) holds true. The S&P 500 has gained more than 4% in the last two weeks, reaching its highest level since December 2007; the Russell 2000 has registered an even larger 6% gain.  However, I absolutely expect a pullback, and soon.  Many stocks are extended to the upside, and chasing those that have already made significant upward moves isn’t the best game plan.  I suspect that this rally is real and stocks will continue to move higher but I would not be surprised to see a number of down days before we get to October.  Europe hasn’t resolved its situation, Asia is mired in a slowdown and we have a Fiscal Cliff staring us in the face with no adult sitting behind the wheel, willing to slam on the brakes before we go over that cliff.  My eyes are open for a surprise ‘left hook’ within the next 50 days.  Whether I’m right or wrong, time will tell.   I remain cautious but optimistic.

Contributor Dempster R. Cherry, Financial Advisor