Last week the Federal Reserve announced it will effectively double their monthly net asset purchases from $40 billion to $85 billion. The Fed also outlined a switch from their traditional date-based guidance to one based on employment and inflation. What does this mean for investors?
We think this news will be interpreted as bullish for equities in a "head's you win, tails you don't lose" scenario. On the one hand, if the economy continues to meander with sub-par growth, the Fed continues to add liquidity, effectively pushing down the U.S. dollar and the price of riskier assets higher.
On the other hand, the Fed will only take away the "punchbowl" when unemployment falls to 6.5%, a level that would require GDP growth of around 3.5%. As for inflation, the Fed indicated it will allow some inflation above its 2% target and allow temporary spikes in food and energy prices to unwind before adjusting its easing stance.
Looking into 2013, we would not be surprised if central bank activity began to look even more synchronized as the Fed's latest policy moves coincide with the efforts of other central bankers. The European Central Bank is poised and ready to expand its own balance sheet when one of its members activates the plan for unlimited bond buying, known as Outright Market Transactions (OMT).
The Bank of Japan is also likely to become more aggressive in easing if this weekend's election goes as expected with a win by the LDP party. The left leaning LDP has been calling for unlimited monetary easing by Japan's central bank. The Bank of England, which recently voted to end its asset purchase program, may have little choice but to revisit Quantitative Easing (QE) as the British stare down the barrel of yet another recession.
There is a good correlation between central bank expansion of balance sheets and stock and commodity market performance. The more money a central bank effectively prints, the more it increases the threat of higher future inflation. This means the more central banks print, the more investors will look for inflation hedges.
Industrials linked to the U.S. housing market recovery should do well, as will emerging market currencies and the corresponding equities.
David Andrews, CFA, is director of Investment Management and Research at Richardson GMP.