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  • QE2 is coming – time to withdraw from the U.S. stock market

    Posted on October 29th, 2010 Peter Tjernström No comments

    In a previous article I argued that the Fed, due to the high stakes involved, would act very carefully when withdrawing from the unconventional monetary policy of near-zero interest rates and massive Quantitative Easing (QE). I took this as a reason to stay in the stock market despite the obvious risk that this type of policy can create asset bubbles. Nine months later the amount of securities held by the Fed is still around $2 trilion and there’s no sign of interest rate increases. Au contraire the minutes from the Fed’s meeting held on September 21st have given rise to speculations about the emergence of a second stimulus package commonly dubbed QE2.

    S&P 500 1 year

    S&P 500 1 year

    So what’s happened on the stock market during these nine months? The S&P500 is up 8% from 1097 to 1184 overcoming a 15% slump as the European sovereign debt crisis unveiled in April-May. The USD is at 0,72 EUR, which is roughly unchanged compared with nine months ago. Meanwhile, the broad index on our home market, the OMX_Stockholm_PI, is up by 14%. During this time the Swedish Riksbank has increased its interest rate in three steps from 0,25% to 1,00%. Many large companies, both US and Swedish ones, are publishing record profits and accumulating cash. I general, demand and sales have some way to go before reaching the top levels of spring 2008, but profit margins are very high due to massive and swift cost cutting during 2009.

    So it seems like staying on the stock market for the discussed period was a good choice, but what about the nine months to come? The Fed’s policy isn’t the only input to that analysis of course but the U.S. still play a major role in the global economy and companies everywhere are either directly or indirectly dependent on the U.S. and the value of the USD.

    My reasoning goes like this: Profit margins can’t get much higher, if share prices are to rise it needs to be through expected sales growth. In the U.S. this cannot, as in previous upturns, depend on domestic private consumption. The U.S. households simply have to pay back debt, and so does the government. Domestic demand is sluggish, the current GDP growth rate  is 2%; way lower that during previous recession recoveries. I doubt that the intention with QE2 would be to lower interest rates further in order to stimulate domestic investment and spending. The main intention would be to increase inflation and thereby (lowering real interest rates and) depreciating the USD. A cheaper USD would stimulate U.S. exports, improve the current account balance and create growth for U.S.-based global companies. Increased inflation will also ease the burden for heavily indebted households.

    This strategy may or may not work. But if it is executed and fails to spur growth, the Fed may be stuck in a liquidity trap from which it can’t get out without severely hurting demand. Hence, QE2 will be a very dangerous route to take. As an investor outside the U.S., I will stay away from the U.S. stock market and from companies with high U.S. exposure, large sales or pricing in USD, until it has been proven that the U.S. economy can grow at an annual rate above 3%.

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