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Why QE and FOMC Tools Do Matter


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#1 MikeyG

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Posted 08 September 2012 - 12:22 PM

There are 3 major asset classes that compete for our money: Commodities, stocks and bonds. Some people might say precious metals has broken off the commodity class and there are four major asset classes. I am agnostic about this and have not done much research or thought because it does not go into my analysis. Branch off the 3 major classes, you have 2 that provide an investor with a dividend or coupon payment. Stocks and bonds. Since Bernanke has made yields of risk free instruments so low by lowering the fed funds rate and using QE tools, stocks have little competition. This is why QE3 is so important to the markets. If Ben decides to make bonds more expensive as compared to stocks, the stock market can and will continue to rally. The last time we had a big fall in the market was in 2011 when bonds were relatively cheap as compared to stocks. The 30 year yield was well over 4% and the dividend yield of stock such as GE (which I use sometimes as a proxy for the market) was under 3%. Now consider today, the yields of those two instruments have flipped.. In "normal" times we will not see a huge sell off with such a huge difference in prices of stocks as compared to bonds. Now, non normal times a such as global recession, this will usually affect the dividend payment of stocks... GDP is the "x" factor... Which why monetary policy can only do so much in a global depression...

#2 fib_1618

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Posted 08 September 2012 - 12:45 PM

Some people might say precious metals

No...just gold...it is the father of all asset classes...been that way since Babylonian days.

As to the rest of your short essay, I think you're starting to get it now.

Money will always search out areas of both undervaluation and/or better total return as money likes to make more money.

QE3? You won't see it as it's not necessary....it's just a distraction/excuse for the "99%" that don't know and/or can't understand why things happen as they do.

Fib

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#3 MikeyG

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Posted 08 September 2012 - 12:52 PM

Some people might say precious metals

No...just gold...it is the father of all asset classes...been that way since Babylonian days.

As to the rest of your short essay, I think you're starting to get it now.

Money will always search out areas of both undervaluation and/or better total return as money likes to make more money.

QE3? You won't see it as it's not necessary....it's just a distraction/excuse for the "99%" that don't know and/or can't understand why things happen as they do.

Fib



Dave,

I could have wrote this "short essay" years ago...

As far as money searching out undervalued assets I agree 100%...

I would lump silver in there with gold due to fact it has been considered a medium of exchange for 1000's of years...

And yes QE3 definitely matters, a bond yield spike is one of the two things that can stop this stock train...

#4 no_mind

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Posted 08 September 2012 - 12:56 PM

QE3? You won't see it as it's not necessary


Fib,

Were both QE1 & QE2 necessary?

Tom

#5 slupert

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Posted 08 September 2012 - 01:22 PM

There are 3 major asset classes that compete for our money: Commodities, stocks and bonds. Some people might say precious metals has broken off the commodity class and there are four major asset classes. I am agnostic about this and have not done much research or thought because it does not go into my analysis.

Branch off the 3 major classes, you have 2 that provide an investor with a dividend or coupon payment. Stocks and bonds.

Since Bernanke has made yields of risk free instruments so low by lowering the fed funds rate and using QE tools, stocks have little competition. This is why QE3 is so important to the markets. If Ben decides to make bonds more expensive as compared to stocks, the stock market can and will continue to rally.

The last time we had a big fall in the market was in 2011 when bonds were relatively cheap as compared to stocks. The 30 year yield was well over 4% and the dividend yield of stock such as GE (which I use sometimes as a proxy for the market) was under 3%.

Now consider today, the yields of those two instruments have flipped..

In "normal" times we will not see a huge sell off with such a huge difference in prices of stocks as compared to bonds. Now, non normal times a such as global recession, this will usually affect the dividend payment of stocks...

GDP is the "x" factor...

Which why monetary policy can only do so much in a global depression...


The three major asset classes are 1) equitys (stocks) 2) bonds ( fixed income) 3) Cash equivalents( both institutional and non institutional money market instruments) many investors use 4 asset classes, adding Real estate to the list.

#6 fib_1618

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Posted 08 September 2012 - 01:25 PM

I would lump silver in there with gold due to fact it has been considered a medium of exchange for 1000's of years...

But silver has rarely been used as a standard in the backing of a nation's or empire's currency...only as a bartering tool.

Regardless, as money is created by a central government, it moves into areas that are in need of stimulus, and when all is perceived as fairly or fully valued, it then moves into the only tangible asset of the classes, and that would be gold. Gold is like a savings account after all other debts have been either stabilized or paid. It is then used, as needed, and if not replenished by further stimulus, eventually drains in value.

So if there is a QE3, you will first see it hitting gold, and 16-18 months later, you will see it hit the equities markets after first moving into commodities and then into the debt arenas.

This idea helps in explaining why stocks continue to move higher here as you are only NOW seeing QE2 efforts having their full impact on the equity markets.

So since QE2 ended in June of 2011, you can figure that this same stimulus will be around into the first quarter of 2013.

And when you add Congress' second stimulus bill that was also passed in early 2011, it's no wonder that the bears have had a tough time of it since last summer.

Were both QE1 & QE2 necessary?

Given the international problems in which everyone knew was sure to come from the fallout of 2008, yes, it has kept the market's buoyant enough to withstand these same global pressures.

But unlike then, gold is still double the value it was when QE2 began, and there's been no break in the advance of the A/D lines of both debt and equities, so one would think that any more stimulus is not really necessary at this time.

Fib

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#7 MikeyG

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Posted 08 September 2012 - 03:16 PM

So if there is a QE3, you will first see it hitting gold, and 16-18 months later, you will see it hit the equities markets after first moving into commodities and then into the debt arenas.

This idea helps in explaining why stocks continue to move higher here as you are only NOW seeing QE2 efforts having their full impact on the equity markets.

So since QE2 ended in June of 2011, you can figure that this same stimulus will be around into the first quarter of 2013.

And when you add Congress' second stimulus bill that was also passed in early 2011, it's no wonder that the bears have had a tough time of it since last summer.



This statement is very generalized...

What you say might be true for normal conditions...

But these are anything but...

In extreme times, such as a global debt crisis this theory does not hold water...

We agree that money moves into undervalued assets, so if we take this to the extreme and an economy crumbles under a debt load as we've seen in some counties in Europe, policy does not matter...

We also have to take a look at Japan, who has had a very accommodative policy and did more QE in terms of Yen then US has in terms of dollars...

Yet there market is down...

This tells me despite efforts by the BOJ to make stocks less expensive then bonds, they did not succeed...

We also have not taken into account any tax implications...

So to recap it's all about the attractiveness of an asset vs asset and central banks can maniputlate that attractiveness under certain conditions...

#8 fib_1618

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Posted 08 September 2012 - 03:35 PM

We also have to take a look at Japan, who has had a very accommodative policy and did more QE in terms of Yen then US has in terms of dollars...

Yet there market is down...

Very different situation there...a very young and different government set up, and you didn't have 1/2 the planet helping them as you do now.

To be sure, these ongoing comparisons with Japan really have become trite in discussions like this one as they haven't panned out as many have predicted over the last 20 years.

For me, I just follow money and leave the worry part to others to wrestle with. If I have no power, why bother?

Fib

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#9 salsabob

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Posted 08 September 2012 - 04:35 PM

There are 3 major asset classes that compete for our money: Commodities, stocks and bonds. Some people might say precious metals has broken off the commodity class and there are four major asset classes. I am agnostic about this and have not done much research or thought because it does not go into my analysis.

Branch off the 3 major classes, you have 2 that provide an investor with a dividend or coupon payment. Stocks and bonds.

Since Bernanke has made yields of risk free instruments so low by lowering the fed funds rate and using QE tools, stocks have little competition. This is why QE3 is so important to the markets. If Ben decides to make bonds more expensive as compared to stocks, the stock market can and will continue to rally.

The last time we had a big fall in the market was in 2011 when bonds were relatively cheap as compared to stocks. The 30 year yield was well over 4% and the dividend yield of stock such as GE (which I use sometimes as a proxy for the market) was under 3%.

Now consider today, the yields of those two instruments have flipped..

In "normal" times we will not see a huge sell off with such a huge difference in prices of stocks as compared to bonds. Now, non normal times a such as global recession, this will usually affect the dividend payment of stocks...

GDP is the "x" factor...

Which why monetary policy can only do so much in a global depression...


What I like about your explanation is that it doesn't include the fallacy that the money the FED uses to buy bonds and mortgage instruments under the QEs and Twist actually gets injected into the economy. That would actually be what most people believe is "printing money" but again that is not what happens with QEs and Twist. Often enough, it is this fallacy that confuses people about the potential for demand-pull inflation. The money provided by the FED through QEs and Twist operations wind up only as "excess reserves" and our themselves impotent in stimulating the economy. These operations on their own are actually deflationary because they remove interest payments into the economy, i.e. less money is injected into the economy.

As you've noted, what the QEs and Twist do is bring down the relative rates of bonds putting a lot of pressure on investors to find returns elsewhere in either stock dividends or in bidding up assets like gold. It is also purposefully intended to cause inflation hysteria.
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#10 pdx5

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Posted 08 September 2012 - 05:11 PM

the fallacy that the money the FED uses to buy bonds and mortgage instruments under the QEs and Twist actually gets injected into the economy.


You get it! The only mechanism available to Fed to stimulate Main Street economy is buying up
US Treasury bonds which enables the government to keep $1+ trillion deficit spending each year.
Fed can't just drop dollar bills from a helicopter.

Creating bank liquidity is not effective unless there is demand for loans from businesses. I am being
bombarded with offers to borrow money so there can't be a shortage of lending money.
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