Permanent Value

Weekly Update: November 1- 5, 2010

Michael La Salle
November 5th, 2010

Stocks Up After Fed Announces QE2

Stocks were up this week after the Federal Reserve Board’s Federal Open Market Committee announced its quantitative easing plan.  The S&P 500 gained 3.60% and the Dow Jones Industrial Average gained 2.93%.

In economic news, personal income slipped 0.1% in September following a 0.4% jump in August.  The loss came in well below the anticipated 0.3% gain.  The manufacturing sector had a big October as the Institute for Supply Management’s Manufacturing Index jumped nearly two and a half points for the month to 56.9.  Expectations were set at the 54.5 level.  Jobless claims were up last week as the new claims level jumped to 457,000, well above the expected drop to 443,000.  The unemployment rate remained unchanged for October at 9.6%.

In quarterly earnings news, Pfizer beat analysts’ expectations this week as the pharmaceuticals giant posted earnings of 54 cents per share.  Aetna also beat estimates after posting earnings of $1 per share, nearly 50% higher than expectations.  Starbucks also surprised this week by posting earnings of 37 cents per share, 16% better than expectations.

QE2 and its Effect on Investors

On Wednesday, the Federal Open Market Committee voted to keep the federal funds rate at zero to 0.25% and to buy $600 billion of longer-term Treasury securities by the end of 2011’s second-quarter.  The program, named quantitative easing or QE2, since it is the second round of quantitative easing since 2008, is intended to get the economy growing at a faster pace. 

The idea behind QE2 is that it can jumpstart the economy since buying such a large quantity of long-term Treasuries raises prices, reduces yield, thus keeping long term interest rates down.  By purchasing these Treasuries, the Fed will also be injecting a huge amount of money supply into the system, allowing private institutions to turn around and lend it back to other companies, boosting the growth of the economy.

With the growth of the economy, it is very reasonable to think that the stock market will also grow, but what will QE2 do to the bond market?  Investors looking to buy bonds with an acceptable yield in the near-future are going to have a tough time since the policy behind QE2 is designed to keep rates low.  For investors who are currently holding bonds, there will not be much movement in the yield curve in the near-term, since yields are already at very low levels.

Over the long term, QE2 may have more implications that are much harder to predict, but one thing we can all agree on is that by increasing the money supply by $600 billion to buy these Treasuries, the Fed is essentially creating higher inflation.  Although higher inflation will create problems for current bond holders with low-yielding bonds, investors holding Treasury Inflation Protected Securities or TIPS will benefit in the long-run.

Market Returns

  This Week Year to Date Last 12 Months Last 5 Years
S&P 500 3.60% 9.93 % 14.93% 0.47%
Dow Jones Industrial Average 2.93% 9.74% 14.37% 8.67%

Next Week’s Economic Releases

November 10 – International Trade, Jobless Claims

November 11 – Veterans Day

November 12 – Consumer Sentiment