Investors who are searching for signs that the Federal Reserve is planning QE3 may want to turn their attention to Europe instead. On Thursday morning, Randall Forsythe of Barron’s wrote about the possibility that the European Central Bank could print money to buy the bonds of the region’s smaller nations, thereby depressing yields and keeping Europe’s debt crisis from spiraling further out of control.
The thrust of the Forsythe’s column is this: While it will take some gymnastics for the ECB to justify such a move politically, it appears to be the only option because the European Financial Stability Facility (EFSF) simply doesn’t have the cash to bring the situation under control. This goes against the central bank’s mandate and is deeply antithetical to Germany’s anti-inflation bias, but it appears to be the only possible solution to the crisis.
Keeping in mind that this is by no means a done deal, and that the situation will probably have to worsen to open the door for this drastic course, investors still need to be alert to the implication of the two key words in this story: “print money.”
According to a Citi analyst quoted in the article, the EFSF currently has €440 billion in its bailout fund. Even if this is increased to €1 trillion, another €1 trillion to €2 trillion is needed to put the crisis to bed.
While this is all theoretical right now, consider that the Fed’s QE2 policy involved the purchase of a much smaller $600 billion worth of securities. That second round of quantitative easing ran from November 2010 through June 2011, but it’s better to use a Sept. 30, 2010 to April 30, 2011 interval to gauge the market impact because this period reflects the anticipation of both the beginning and the end of the program (see chart).
Consider the returns of various asset classes, as gauged by ETF performance (according to Buyupside.com), in this eight-month time frame:
- SPDR S&P 500 ETF Trust (NYSE:SPY): 20.69%
- iShares Russell 2000 Index Fund (NYSE:IWM): 28.83%
- SPDR Gold Trust (NYSE:GLD): 19.12%
- iShares Silver Trust (NYSE:SLV): 119.99%
Click to EnlargeEven though its economic impact is debatable, it’s clear that QE2 had a significant effect on the markets.
Now, it may be time to start thinking about what 2012 could look like if the ECB goes through with a larger money-printing scenario of its own. Not only would the global markets be flooded with liquidity, but investors could put their worries about Europe on the shelf and begin concentrating on an environment of slow, steady growth and healthy corporate earnings. In short, any announcement of a plan that involves the ECB printing money would likely be rocket fuel for the markets.
What to buy in this scenario? Take your pick — just about everything would benefit except U.S. Treasuries. But based on the history of various Fed easings that have occurred in the past 20 years, the assets most likely to gain from a surge in global liquidity are emerging markets stocks. In the more recent past, physical gold has been a key beneficiary of central-bank shenanigans. Another potential winner could well be the higher-beta plays in economically sensitive, beaten-down areas such as coal, steel and fertilizer.
Although it’s still far too early to make any large trades based on hopes for historic bailout measures, it’s time for investors to put this issue on their radar screens and begin paying more attention to comments from ECB officials.
Also, this may be a one of the rare occasions where it could pay to look for “lottery tickets,” in this case, via small bets in out-of-the-money call options expiring in January, 2013 — especially if the market provides an entry point via any weakness in the next two months.
The bottom line: This scenario remains a long shot, but it also creates the potential for a historic trading opportunity. Stay tuned.
