Current
Signal Performance as of
Signal
Type |
Trade
Date |
Return
since issued |
|
|
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World |
U.S. |
|
Nasdaq
100
(QQQQ)
|
Russell
2000
(IWM)
|
S&P
500
(SPY)
|
|
The Russell 2000 (IWM), S&P 500 (SPY) and Nasdaq 100 (QQQQ) respectively gained 4.94%, 3.57% and 2.86% over the five-day span. All three ETFs remain located well above both their 50-day and 200-day exponential moving averages (EMAs).
For its part, our World portfolio posted a 4.63% gain this week. The portfolio consists of the 5 top-ranked world ETFs as of October 8, which marked the beginning of the current 4-week holding period. The World portfolio is being rebalanced today, as the current 4-week holding period is now over.
Our current Buy signal remains in effect.
When the Fed holds a party, everyone chooses to come! At
least that seems to be the stock market's view of this week's
confirmation that the Fed will embark on QE2 to the tune
of $600B (see definition of QE2 in our FAQ of the Week below).
Focusing their generosity on the 2.5-10 year part of the
Treasury bond world leaves the long-term bonds to seek their
own, unhibited price and yield equilibrium. The results
have been interesting as the market seems to have expected
the Fed's announced focus.
Chart 1: U.S. Treasury yields diverge in anticipation
of Fed QE2
The long-term U.S. Treasury bond yield has risen steadily
throughout September and October despite the promise of
Fed bond purchases. This increase in yields breaks a hefty
rally in prices that began in April. The increase in long-term
rates could be just a simple mean reversion where prices
give back some "excess" gains that built up during
the deflationary concerns of late summer. Or it could be
a vote by investors that the U.S. economy looks a little
brighter going forward and/or inflation will be rising,
both of which would cause a ramp higher in interest rates.
Chart 2: U.S. Treasury bond rally breaks
We can gauge a bit of the market's view of inflation by
looking at the performance of the inflation-protected Treasuries
(aka TIPs). There, we see that the inflation expectations
have been picking up. In fact, demand was so strong for
a recent TIPs auction that the bonds were sold at a NEGATIVE
yield. (We may worry about the size of the U.S. budget deficit,
but you have to admit we are financing at a great rate these
days!).
Chart 3: Investors increase inflation expectations
Of course that negative yield is a bit of a misnomer as
the yield will ultimately be adjusted for inflation. Still,
there is no question that investors have dramatically shifted
gears over the past couple of months, from worrying about
deflation and double-dip recession to a bit more sanguine
view of the world. After all, interest rates throughout
Asia are being increased to try and control
swiftly growing economies. To wit, China's growth rate remains
around 9% and shows no real signs of slowing.
While most commentators doubt that the Fed's QE2 program
will bring about any dramatic change in the U.S. economic
landscape, it certainly will keep downward pressure on interest
rates and continue buying time for business and consumer
confidence to be rebuilt. When that confidence returns remains
to be seen, though recent retail reports have improved somewhat,
as have manufacturing indicators. If they continue improving,
those indicators will eventually lead to a betterment in
the stubborn U.S. unemployment rate, though it's likely
that the U.S. labor situation has permanently changed for
many folks.
This rally has been looking an awful lot like the March-April
move higher up to this point. This week might have brought
a different tone, however. The March-April move upward hit
a wall in mid-April when emerging market stocks rolled over.
A couple of weeks later, the U.S. markets followed suit.
This time, the emergings underperformed domestics in October,
consolidating their September gains. This week, the international
stocks appear to be breaking out anew.
While these macroeconomic forces battle it out day-by-day
and markets do whatever they choose to do, our Buy signal
has led us to the right trade over the past couple of months
and remains blissfully unmoved by the emotional forces that
cause trouble for so many investors, such as whether the
market is "justified" in rallying in the face
of such dire circumstances (opinion can be a thorn in our
investing side all too often).
QE2
refers to a program of "quantitative easing" which
is a term coined to cover the Fed's stated intent to purchase
bonds on the open market. By being a large buyer in the
bond market, the Fed can work to influence interest rates
lower which hopefully leads consumers and businesses to
find borrowing money and generating economic activity more
attractive. Historically, the Fed's role regarding interest
rates has largely been held to the very short-term through
their setting of the Fed Funds target rate. This rate has
direct impact on very short term U.S. Treasury securities
(aka T-bills).
Through becoming an active and very visible participant
in the longer-term U.S. Treasury bond market, the Fed expands
its influence on interest rates compared to its past methods.
of course, the Fed, nor any other government entity, can
force the entire economy to sustainably grow. Thus, they
do whatever possible to try and jump-start business and
consumer spending and investment.
The Fed embarked on its first round of quantitative easing
(QE1) late in 2008 as a way to bring sanity and calm back
to the credit markets. That worked in beginning to restore
credit market confidence; however, it's been less successful
in boosting consumer and business confidence in such a way
that the economy returns to any sustained and lasting health.
At the beginning of this year, the question was how the
Fed would step back from its hefty role as a bond market
buyer - how they would unwind their quantitative easing.
However, this question never got an answer. As the economy
failed to take flight through the middle of 2010, the Fed
took steps to remain an active buyer. The QE2 program, with
some details announced this week, attempts to further remind
the market that the Fed will do everything in its power
to keep interest rates low to encourage borrowing and spending
by businesses and consumers. As a natural outcome of this
program, the Fed is also making the near-term financing
of the U.S. budget deficit a whole lot cheaper. The actions
also push the value of the U.S. dollar down making anything
we import (such as oil) more expensive. That last bit is
where the potential for inflation comes in. If the Fed goes
too far down the path and the market shifts to believing
the U.S. dollar (and economy) will not find support through
eventual higher interest rates, inflationary expectations
could become ingrained in the thinking of businesses and
consumers leading to a hard-to-control spiral of higher
prices. We're a very long way from that scenario. But that's
the worry of the doomsday crowd as the Fed continues to
throw money at bonds. Initially, at least, stock investors
seem happy about QE2 at least! But investors are also bracing
for higher inflation and, eventually, higher interest rates
as discussed in our weekly update above.
Warm wishes and until next week.
The TimingCube
Staff
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