Nolte Notes for the week of September 17, 2012Paul J. Nolte - Monday, September 17th, 2012
Ben Bernanke, doing his best Buzz Lightyear impersonation, told the world that quantitative easing would last “to infinity and beyond”. We can dispense now with the numbers after QE, and use “∞”, since the “as long as necessary” language is now a part of monetary policy. The goal is now very simple, make everyone wealthy by way of higher stock prices so they’ll spend money and get the economy going. The Fed is willing to live with higher than “normal” inflation for longer than “normal” until employment gets closer to “normal”. Investors, seeing that the Fed is now willing to back the stock market went on a buying spree, pushing stocks to levels not seen in four years. Many see the actions of the Fed as a desperate measure and they have finally shot their last bullet. However, Bernanke counters that the Fed does have additional resources to bring employment down. Unfortunately, the Fed has but one tool, monetary policy and everything is looking like a monetary solution. Lasers have been set from stun to kill.
The change in Fed policy may have been “forecast” by the markets, as investors had begun rotating out of utilities and into basic materials stocks. Along with stocks making multi-year highs, the weekly momentum is now at highs not seen since ’98. The actions by the Fed have now rendered much of the economic data useless, as the Fed has promised to keep the monetary spigots open, supportive of still higher equity prices. That being said, the very strong back-to-back weeks should allow stocks to continue higher over the short-term. A correction is coming, we’re never sure when, but many of the components for a correction are in place. Unfortunately, the longer and higher the markets go without at least a breather (now pushing 15 weeks), the larger the subsequent decline. However, given the Fed backstop of the markets, the inevitable correction will likely be followed by ever-higher stock prices. The markets are only focused now on central bank activities – and they are now all in.
Bond investors hoping to see higher yields (or at least some yield) will be disappointed for at least the next three years. The Fed actions have put a bulls-eye squarely on this group. While the goal is to keep rates low to allow for refinancing and added borrowing, the fact is yields have increased during the various QE programs as investors sell bonds and buy equities. Not helping bonds are the much higher commodity prices. Pushing the dollar lower and goods priced in dollars higher, the promise of Fed actions have lit a fire under gold, now up 25% in six weeks and crude oil prices up 20% since July 4th. The bond model remains negative, meaning higher interest rates remain in our future.
The rotation discussed last week shifted into high gear this week, as oil and basic material stocks were the stars last week. If inflation is the (now) goal of the Fed, these groups stand to be huge beneficiaries. The shift in industry groups is also seen in our ranking of the groups. Energy stocks were on the bottom in early July and are now in the middle of the pack, but moving higher quickly. Utility stocks have gone the other way and now reside at the bottom of the group ranking. The markets won’t go straight up from here, but the character of the market has changed to one of chasing higher yielding “safe” stocks toward more inflation sensitive stocks. During any coming corrections, I would expect that these inflation/economically sensitive issues decline less than the broad markets. Since they have been out of favor for well over a year, they should lead the markets through yearend and maybe into the New Year. The Fed statement has changed the rules of the investing “game” and risk is back on.
The Fed focus is on creating wealth via the stock market. They are willing to accept higher inflation to do so and will be watching employment to gauge when to let their collective feet off the gas. Our reaction is to gradually add more equity exposure while cutting bond holdings. The increase in equities will be via more inflationary sensitive sectors like energy and basic materials. Bondholders should remain biased toward corporate bonds. They continue to perform well, even as treasury rates increased.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
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