Most people don’t really understand the Fed’s quantitative easing policy.
It has many different angles in terms of what it affects, but I’m going to stick to how it affects your investments. Quantitative easing means the Fed is using about $80 billion every month to go into the bond market and buy up bonds. As we remember from Econ 101, when buying demand increases, prices go up. Yields, or interest rates, move inversely to bond prices, so as those prices have gone up, yields on bonds have gone way down.
The result is folks that used to rely on bonds to provide stable fixed income for their portfolios have seen that income dry up. To get that yield back, they have sold out of their bonds and bought stocks instead — particularly those that offer yields like REITs, preferred stocks, BDCs, and dividend-paying stocks. Thus, there’s been this big rush out of bonds and into stocks, creating more demand for stocks, driving those prices up.
That trend has been going on for some time. If you’ve read my columns in which I consider buying Company X or Company Y, you’ve probably seen me complaining about how expensive the stock is, and telling investors to stay away for the time being.
The question we are all wondering is how long will QE policy remain in place? Because once the Fed takes its foot off the gas pedal, it’s going to have to ease it off slowly or the market will crash as everyone rushes back into bonds.
One thing is very clear: Ben Bernanke is a student of the Depression. He knows the Fed didn’t buy enough back in those days, so he’s going to power ahead until it’s very clear the economy is on the mend.
Right now, the economy’s a mixed bag. The Labor Force Participation Index, which is the number of people in the work force, is at a 30-year low. It has fallen more in the past five years than any five-year period, with more and more people leaving the work force because they’ve given up looking for work. As long as the LFPI keeps rising, things are not likely to improve.
The PMI fell to 49%, its lowest since June 2009, and a reversal of a trend where it had been growing. Retail and food service sales fell 0.3% in April, after being flat from January to February and moving up significantly in March. Housing appears to be recovering, but on closer examination, it’s mostly speculative buying. Wages remain stagnant. Gold prices cratered but have stabilized. GDP was decent, coming in at 2.4% in Q1.
When you add up all the data, it suggests a weak recovery. Things appear to be on the mend … but slowly. It’s enough to suggest the Fed is keeping a close eye on things, and while Bernanke isn’t close to stopping QE, we’ve probably moved out of the critical zone to one where being mindful and watchful is the order of the day.
To me, this all suggests that one should remain fully invested, but be ready to take a few coins off the table if things continue to improve. Your own choices are best for your own portfolio, but the yield-driven ETFs are looking particularly attractive right now. With things as they are, I’d suggest looking at some of these:
- Vanguard REIT Index (VNQ)
- E-TRACS Wells Fargo Business Development Company ETN (BDCS)
- iShares S&P U.S. Preferred Stock Index (PFF)
- iShares iBoxx $ High Yield Corporate Bond (HYG)
As of this writing, Lawrence Meyers was long BDCS and PFF. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.