QE3: Time to Take Profit or Stay in the Trend?

S&P 500 has grown by 2.5% since the beginning of September, 2012. The market owns this growth to 2 days: the 6th of September, when the president of the European Central Bank announced the repurchase of problem assets (S&P 500 grew by 2.02% in a day) and the 13th of September, when Ben Bernanke, the Head of the FRS announced the MBS repurchase for $40B per month (S&P grew by 1.63% in a day). The rest of the month investors were quiet and trying to comprehend what to do next: sell based on fulfilled expectations or buy commodities, high yield bonds, and risky stocks.

Frankly, I tended to consider that QE3 in the US would be postponed to a later date due to the reasons I had described earlier, in the beginning of September 2012:

“Unfortunately, today the countries’ monetary politics can have more influence over the financial markets than the fundamental state of economy. But this only concerns short and mid-term perspective. A speculative cause for the developed markets growth is the expectation that the FRS and the ECB will be able to give their support through the quantitative easing programs when required. In the U.S. more and more FOMC members express their confidence in the necessity of further monetary stimulation. The latest comments suggest that the FRS is ready to launch QE3 “fairly soon” if the state of the U.S. economy leaves much to be desired. Such expectations allow approaching the risk of investing into shares with more confidence. On the other hand, taking into account almost 0% interest rates, it is doubtful that the QE will have a tangible effect over the American economy.  The expectations of the market drug are accounted for in the prices of shares, nevertheless the QE3 amount and the announcement of bond redemption are able to support the stock rates in the short-term.

By the end of July 2012 labor force in the U.S. was 155 million people. Population growth and labor force at 1% per year in America (without dropping the unemployment rate) means that the U.S. economy should generate additional 1.55 million jobs per year or up to 129 thousand jobs per month. In order to decrease the unemployment rate the number of generated jobs should be significantly higher. Since the beginning of the year, Nonfarm Payrolls average growth rate was 151 thousand per month. In order to obtain a 2% and more annual GDP growth, the productivity growth rate should suffice to cover the lack of labor force. In 2012, more than 1% productivity growth rate shows that the lack of labor force is covered by the productivity growth”.

So, the FRS is concerned with the employment growth rates while some of the leading indicators signify that the deceleration of the American economy may continue. At the same time, in early September 2012 I pointed out:

“It is argumentative whether the FRS should implement the quantitative easing on the background of the latest unemployment and housing market reports, though the speculations over the topic continue. Today this FRS decision is not only economic but political as well: who to support in the election race. Supporting the market before the elections against fair housing market and unemployment rates seems as obvious support of Barak Obama. However, today there is no certainty as to the victory of either candidate, which is why it would be politically correct of the FRS to abstain from any actions until the results of the elections”.

After the QE3 was announced, the Republicans claimed that the FRS supported the current President. The ECB decision on repurchasing bonds was more probable, in my opinion:

“The Euro zone economy stimulating measures will be discussed at the ECB Monetary Politics Committee meeting in September 2012. The announcement of a new LTRO program is less probable compared to the sovereign bonds redemption program. LTRO demands pledge assets from banks: do they have enough mortgage assets? Securities Market Program will come handy for refinancing Spain and Italy debts and decreasing interest rates for them. Probably, the redemption will begin in the beginning of fall 2012 and the risks that the ECB will end up containing even more trash assets increase”.

The question of how effective is QE for the real economy is highly debatable. I have not seen any fundamental research on this matter (correct me if I am wrong), but indirectly we cannot but take into account  the current housing market situation, for example, which has improved a lot due to almost double decrease in 30 year fixed mortgage rates compared to the pre-crisis level. In the beginning of September 2012 I wrote:

“In the first half of 2012 the average growth rate of building permits was 25.8% compared to the same period last year. The average growth rate in 2011 was 1.2%.  The average Housing Starts growth rate was 27% since the beginning of the year as compared to the same period last year. In 2011 this figure was 5.4%.

The average rate of new homes sales was 14.9% in the first half year compared to the same period last year. The average growth rate of the index was -3.45% in 2011.

The investors believe that construction market growth would cause the growth of related industries and thus become of the fundamental pillars for healthy economic recovery. Despite the fact that the construction sector employment is only 5.5 million people (which is only 3.6% of the total U.S. labor force), the multiplication effect can become one of the driving forces for further growth. At the same time, construction companies do not rush to hire: the employment rate in the U.S. construction industry has hardly changed since the beginning of 2010 and is far from the 7.5 million people during the pre-crisis period”.

With the realization of bonds repurchase scenarios in Europe and the United States, it is high time to analyze which sectors benefit from the quantitative easing programs, specific feature of which for the first time is that the volume of the repurchased bonds is theoretically unlimited.

First of all, per the FRS purchase volume: is it much or not? According to UBS, it is much: “The alternative of tilting purchases toward MBS implies that the QE program would need to be quite protracted. Monthly supply of conventional 15yr, 30yr and 30yr GNMA has averaged about $85-90 billion over the past year and the Fed is already buying about $25 billion. The Fed might be able to buy another $40 billion without disrupting the market. Assuming that the Fed does a $600 billion program with 75% in MBS, it would need to buy $450 billion in mortgages, so in our estimation the program would need to last nearly a year”.


Prior to analyzing industries, let’s see what markets and industries showed the highest growth from January to August 2012.

Industry Index


YTD end of Aug. 2012

NYSE Arca Biotechnology Index


S&P Retail Index Index


KBW Bank Index


AMEX MS Healthcare Products Index


Nasdaq Composite Index


North American Telecommunicatins Index


CBOE DJ Reit Index


NYSE Arca Disk Drive Index


DJ US Chemicals Index


NYSE Arca Airline Index


S&P 500 Index


S&P Insurance Index


AMEX Interactive Week Internet Index


NYSE Arca Computer Hardware Index


Phlx Semiconductor Index


NYSE Arca Pharmaceutical Index


DJI  Dow Jones Industrial Average Index


S&P Global Telecommunications Sector Index


AMEX MS Healthcare Services Index


Philadelphia Oil Service Sector Index


NYSE Arca Defense Index


NYSE Arca Natural Gas Index


NYSE Arca Oil Index


Dow Jones Transportation Average Index


Phlx Utility Index


NYSE Arca Securities Broker Dealer Index


NYSE Arca Networking Index


CBOE Gold Index


CBOE 10-Year Treasury Yield Index


DJ US Iron & Steel Index


Source: Oxenuk Management, LLC

Region Index


YTD end of Aug. 2012







MSCI VIETNAM Standard (Large+Mid Cap) None


BSE 500




CAC 40


MSCI ACWI IMI (Large+Mid+Small Cap)


Dow Jones


S&P/ASX 200




Jakarta Composite


MSCI EFM AFRICA Standard (Large+Mid Cap)


Hang Seng


TSEC Weighted






MSCI SOUTH AFRICA Standard (Large+Mid Cap)


MSCI AC EUROPE Standard (Large+Mid Cap)


MSCI EAFE IMI (Large+Mid+Small Cap)




FTSE 100






Shanghai Composite




MSCI EM LATIN AMERICA Standard (Large+Mid Cap)


Source: Oxenuk Management, LLC.

In total, judging by the 8 months of 2012 results, the broad markets growth leaders are the developed economies, namely that of the U.S. (+11.7%),  Germany (+18.2%) and France (+8.02%), where the situation is questionable but is anyway better than in other developed and emerging countries.

Emerging markets of Russia +1.5% (capital drain due to political risks), China +0.25% (decelerating economy being the basis of the demand for investments and commodities), Latin America -2.2% (sudden slowing of growth down to 2% in Brazil, political risks in Argentina) are the outsiders.

Per American industries, the retail industries growth of +23.9% is very unusual despite that the defensive industries show a more modest result compared to the market growth (the second after biotechnologies +34.15%). What is that: an attempt to protect itself from a possible storm on the market?

Per biotechnological industry, the investors may have a feeling that the industry is living a bright life independent from market movement in general. For example, in 2008 when S&P dropped by 38.5%, the biotech industry index showed the lowest drop among the U.S. industries (-17.7%). At the same time, in 2009 when S&P grew by 23.5% the biotech index grew by 45.6% with continuing growth by 37.7% in 2010.

By the results of the past 8 months of 2012 the leaders of growth are drugs producers (+19.1%) and telecommunication companies (16.9%) which are also defensive. Among the cyclical industries, the banks perform best compared to the broad market index (+11.7%) being the main claimants for the benefits of QE3 (+19.8%), construction companies and Real Estate due to recovery in the housing market (+15%).

So, what can we expect after QE? Let’s apply to the theory. Based on intensified inflation expectations due to another money printing round, gold has a good chance to perform better compared to the broad market index in the mid-term taking into account that the price of metal in its earnings lags behind both the S&P index for the last 12 months and the YTD (year-to-date).

Based on intensified QE3 expectations we will see the US currency cheapening compared to the currency basket and gold price growth which is a natural phenomenon. At the same time, GLD price movement is in % compared to the SPY movement for the last three months, i.e. gold did not over-perform the broad market which indirectly signifies the weakness of high inflation expectations of the market participants at present.

I would like to point out that investing into gold is not an equivalent of investing into gold mining companies. In the graph below we can observe the comparison of price movement of SPDR Gold Shares (GLD) representing investments into gold bullion to CBOE Gold Index (GOX), representing investments into gold mining companies. Investments into gold mining companies significantly underperform investments into gold YTD. We could witness a similar picture in 2008, for instance. Despite the fact that the price of gold bullion which is represented by GLD index almost didn’t change in 2008 (91.40-91.31), CBOE Gold Index which represents the companies in gold industry declined by 20.6%.

 Theoretically, oil industry has a chance of growing in the result of weakening of the US dollar and conservation of prices at least at the current level. At the same time, QE3 expectations in summer 2012 have already promoted leading growth of oil prices as well as of oil companies’ shares prices compared to the broad market index. Oil and oil industry earnings dynamics have been significantly lagging behind the broad market index since the beginning of 2012. Unlike the gold market, gold mining companies’ shares prices movement (NYSE Arca Oil Index-XOI) outruns that of the oil prices (United States Oil Fund-USO) or coincides with it depending on the period in time.

More risk-prone investors may also consider Oil Service Industry represented by PHLX Oil Service Index (OSX). The industry has underperformed the broad market index both since the beginning of the year and for the last 12 months due to slowing down of investment growth tempo in the economy and the oil prices dynamics. Oil prices growth may positively affect the oil companies’ decisions on capital investments. The Oil Service industry movement correlates with the oil prices movement but is more volatile, meaning higher earnings when the oil price increases and lower earnings (a large loss) when the prices drop.

One of the consequences of the US real estate market revival is that home – building companies stocks reveal multiple leading growths compared to the broad market index for the last 12 months and since the beginning of the year. The graph below suggests the comparison of iShares Dow Jones US Home Construction Index Fund (ITB) earnings with that of S&P year-to-date. QE3 is officially targeted at further supporting the housing market through repurchasing mortgage-linked debt from the open market and cutting interest rates. I am not bearish on any of the stocks of homebuilders in the long run despite the over 100% growth of the home-building index for the last 12 months. The home building companies will perhaps reveal further growth if the interest rates are supported or cut. Besides, this market is far from recovery (and will hardly recover in the coming years) especially considering the unemployment level and growth in the construction industry.

I’m neutral on the bank sector stocks in the foreseeable future. On the background of QE3 expectations, the banking sector stocks (PHLX/KBW Bank Index-BKX) have already shown the leading growth compared to the S&P index since early June 2012. One may expect speculative growth of financial market stocks in the short-term. Per banks’ fundamental indexes, it is a highly disputable question. On the one hand, we see the improving of balance sheets, credit costs cut, expenses’ control and cutting of provisions for credit losses. On the other hand, the quality of banks assets is still under question, the sector regulation tightens, credit portfolios and interest income growth is slowing.

On the background of money inflow expectations, the investors have already bought the stock of leader companies. The stocks of outsider companies are bought last when there are no more good products on the market, and on the current stage these are the stock of cyclical companies, beginning with steel, coal and iron ore producers. Does this mean that companies such as Rio Tinto and ArcelorMittal are good investment? On the one hand, the increasing risk appetite and the US dollar cheapening can bring to speculative jump of, let’s say, iron ore and steel prices. On the other hand, investment demand for such commodities is mostly defined by China. It consumes over a half of the global steel market, for example. Therefore, from the fundamental point of view, it is hard to expect the large increase of physical demand for such commodities when China economy is slowing down, Shanghai Composite is refreshing it lows and the global production indexes are slowing as well. Personally I am inclined to base on fundamental decisions.


The forecasts for gold, oil or metal prices voiced above are a theory. The FRS official attempt to support the housing market through QE3 and the unofficial attempt to utilize Wealth Effect when the individuals possessing stock that grow in price, will increase their consumption, in the current situation has a doubtful long-term growth potential, nevertheless benefitting the housing market. The mere QE3 expectations have already brought to situation when the US stock indexes are on their 4-5 year maximums. The unusual point in the assets repurchasing programs in the US and Europe is that they are not limited in time or volume, theoretically. At the same time, from a speculative point of view, will the investors tend to massively sell stocks when $ 2 billion of “fresh money” are being inflated in the market daily? Hardly, although they are not prepared to massively purchase: the expectations came true, it seems like one can sell based on the expectations, but the “fresh money” is about to come. I think that the current stock market rally with decreasing volumes is characterized by fear rather than by greed and euphoria. The market is in the hands of speculators, meaning that one can expect the levels to remain unchanged until some shocking events or increased volatility mainly in cyclical industries. In cases like this, personally I prefer the stocks of defensive companies that sell commodities and services to end consumers.



This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service. Performance data shown represents past performance. Past performance is no guarantee of future results. No part of this article may be copied, distributed, transmitted or published without the prior written consent of the author.





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