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QE3? Investor Strategy

09/07/2012

In the wake of this morning’s disappointing labor figures, multiple economists have suggested that QE3 is certified when the FOMC meets next Wednesday and Thursday, September 12-13, for the sixth time this year. The two final FOMC meetings for 2012 will be on October 24 and December 12.
 
Is QE3 coming? What is certified is an end to this summer’s “sit on their hands” FOMC meetings, so yes, something is coming… What could it be?
 
•  Throughout 2012, I have suggested that targeting the agency mortgage-backed securities market would be impactful and favorable for investors. After this morning’s labor report, spreads on those securities have fallen to their lowest levels since June 2007. The market is expecting the FOMC to implement a monthly program to buy those securities.
 
•  Less impactful, and I expect already priced in, would be language extending the guidance on a possible Fed fund rate hike into 2015. This has been discussed at length, and is also somewhat meaningless since unforeseen conditions can always warrant altering the guidance.
 
•  Also less impactful would be the direct purchases of Treasuries. The Treasury market gives no indication of any concern to cap yields. In fact, it’s been just the opposite. A rise in yields might be needed to encourage nontaxable fixed income investors to rotate into riskier assets. If a Treasury purchase program is implemented, it would not have the targeted future dates as QE2 did and also somewhat concerning since it does not specify an extended program life. Again, it would be month to month and could change if unforeseen conditions present themselves. Investor should not alter portfolios with such shallow intention directives.
 
Overall, I expect the only impactful FOMC action investors could allocate toward would be agency mortgage-backed securities; the rest is priced in, and quantitative tools being discussed have already been implemented in the past. They had their day – in 2010, not 2012.
 
I would closely watch the value of the U.S. dollar as the introduction of QE3 may place the prevailing bull trend for the U.S. dollar in jeopardy. That is actually a concern for me since it would signal eurodollar appreciation. The monetary policy easing needed most remains in Europe. Europe needs the cheapest currency to stimulate demand for its exports and actually create modest inflation in Germany so that the periphery can compete within the eurozone.
 
Finally, as I have written throughout the third quarter, the path for the S&P 500® Index (SPX) continues to point higher. However, as always in the disciplined approach to calculating risk, I urge investors to use these four indicators to quickly confirm the need to neutralize the overall bullish bias:
 
1.  SPX technical formation (Figure 1.1) – First, in the near term, please use the previous resistance level of 1391.74 as the now solid near- term support. Since closing above 1391.74, the SPX has not broken back below that level. A break below 1391.74 on a closing basis does neutralize the near-term bull scenario. Additionally, the 200-day moving average has risen to 1342.09 – certainly a line in the sand for 2012’s overall performance.
 
2.  Continue to use the German DAX, which has now appreciated 14% this quarter, as a critical indicator. The DAX is outperformimng all of its developed nation counterparts and major emerging market nations this quarter despite the continued eurozone strife. The DAX is an excellent indicator for the path of global capital markets.
 
3.  Technology is the sector to watch within the SPX. Currently +22% year to date, technology is in the midst of a historically seasonally strong period. As goes technology in the coming weeks, so shall the SPX.
 
4.  Corporate Earnings will be reported in just one month. Although much can change before the early October reporting period, continued positive EPS and sales growth will soften the magnitude of any market correction. Conversely, negative EPS and sales growth would be a headwind for further SPX appreciation.
 
Figure 1.1 S&P 500 Index (SPX) Year To Date

Source: Bloomberg

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