Profits, Big and Small

by Nigel Bolton-Shaw on September 27, 2012

Moneycontrol.com tells us that markets will learn to welcome QE3. In doing so, the article deals with issues that we’ve already written about – and poses questions as well.

The article’s fundamental questions are, “Will QE work in boosting the economy? Will it lead to an upturn in inflation? And what will the impact be on asset prices, notably global equity, bond and commodities markets?”

These are significant. In our article, today, we’ll examine the answers and add questions of our own.

Here’s some more from the article:

The US economy is showing signs of being at a turning point. The housing market has formed a base and it is realistic to forecast house prices will recover 5 per cent or more in the next year. Real consumption has improved with a trend recovery in personal incomes.

Given spare capacity in the US and the global economy, the lack of wage pressure and the limited impact of commodity prices on core inflation, it is premature to forecast that inflation will accelerate significantly …

Investor sentiment still remains subdued with a high degree of scepticism over the outlook for growth and corporate earnings. While there has been a clear flow of investor capital out of money markets into corporate, high yield and emerging debt, capital flows into equities have been relatively muted.

Given the probability of near zero returns in money markets for at least the next 2-3 years, negative real returns in most bond markets and the now narrow spreads in corporate and emerging debt markets, QE should drive funds into equity markets …

While a policy mix of exceptionally easy monetary policy and more austere fiscal policy is negative for the US dollar, particularly against the emerging currencies, the impact of QE on commodity prices – excluding precious metals – is less clear.

Therefore, although risks remain, in particular resolving the US “fiscal cliff”, investors may be surprised by the improved effectiveness of QE and the positive impact on markets …

OK … good analysis. We learn that the US economy is picking up, and that this actually is in contrast to Europe. If Europe continues to degrade, then this could certainly have an effect on the US recovery.

Additionally, the US is facing its own “fiscal cliff” as the article mentions. Goldman Sachs, as we’ve mentioned before, has been concerned enough to warn its investors to get out of the stock market because of a lack of confidence in Congress.

Goldman’s position is that the United States is looking at a 12 percent drop in stock market averages because Congress will not address the necessary issues regarding the nation’s solvency. A lack of action regarding taxes and the nation’s debt ceiling will knock down stock averages in a big way. Worst case: a GDP that actually contracts in 2013.

However, the larger issue remains the tremendous amount of money that has been printed by central banks over the past four years or so.

Moneycontrol.com’s article is probably correct in its assessment. The market may already have “priced in” some of QE3 but how do you price in an open-ended program?

Over time, as the article points out, money printing tends to boost stocks – and commodities as well.

The real issue, which the article doesn’t discuss is what happens when the money currently trapped in bank coffers begins to circulate?

The Fed will have to tighten hard. But before then there are likely profits to be made. Maybe even big profits.

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