OPENING POSITION
On September 13, 2012, the Federal Reserve announced its third round of quantitative easing (QE3). What was different about this round? The Fed was buying mortgage-backed securities to the tune of $40 billion a month instead of the usual bonds. Something else was different this time around in that the Fed was doing this during a time when the equity markets were getting stronger.
The equity markets have been rallying since June of this year, and if you look at the daily chart of the Standard & Poor’s 500 or any of the other broader indexes, you will note that they all looked overbought. My thinking was that the possibility of QE3 was already factored into equities.
However, once the Fed made its announcement, we saw a surge in investor sentiment, which sent equity markets charging into a further rally mode. There were no signs of a pullback that day, and the markets showed that they still had momentum.
The Fed also kept interest rates at their current levels, which was another reason for investors to rush to invest in equities as opposed to bonds. Since the objective of QE is to promote growth in the economy — the Fed did say it would continue to do so until unemployment rates went down — you can expect to see a rise in the commodity markets as well.
Right now, as I write this, we have an environment where equities and commodities are rising and bond yields are low. How long can we expect this to last? It wasn’t too long ago when all we heard in the news was the term “financial cliff.”
We are coming close to the end of the year, and we have a very important Presidential election to observe. We also have a tremendous amount of political unrest and turmoil in various parts of the world. Not only that, we have to keep an eye on the Eurozone, which continues to struggle with their debt crises.
There are too many unresolved issues, and given the outcome of previous rounds of quantitative easing, I wouldn’t be surprised if the rally we were seeing in equities were short-lived. It’s always a good idea to take some profits when a market looks overbought. As Anthony Trongone states in his article in this issue, “Warning: Bear Activity,” market downturns arrive unexpectedly and are beyond our control. The best we can be is proactive.
Jayanthi Gopalakrishnan, Editor