In the last few days, there have been several articles written about the possibility of a QE exit and its implications on asset classes. In this article, I will discuss the reasons for believing that there will be no QE exit in the foreseeable future.
A probable QE exit can be backed primarily by two reasons -
- Inflation is trending higher leading to policymakers shifting to restrictive monetary policies
- Economic growth in the U.S. and globally is robust signaling a QE exit
I will investigate both these reasons to back my conclusion stated above.
The chart below gives the core and headline inflation in the United States. Inflation has declined meaningfully in the recent past indicating relatively weak economic activity. Therefore, if this metric is considered, there is no reason for the Fed to go for a QE exit at a time when the economy seems to be weakening. I will discuss the economic indicators later in the article.
The scenario is no different when one looks at the global inflation data. As the chart below shows, inflation has sharply trended down in the recent past for the advanced as well as the emerging economies. This is not surprising as the eurozone in a recession and the U.S. is experiencing relatively slow growth. For the emerging economies, economic data from China continues to disappoint and India is also experiencing weak growth due to policy paralysis. The inflation data is therefore in sync with real economic activity globally.
Considering the inflation in the U.S. and inflation globally, I would conclude that the policymakers might consider expanding their QE program in the near-term rather than cutting down on the stimulus.
Coming to the point of economic growth, the inflation data already give an indication of the direction in which the global economy is headed. A clearer picture emerges on looking at the global purchasing manager index. The global PMI has shown weakness in the recent past with the manufacturing sector PMI at 50.5 for the month of April 2013. The global manufacturing sector is therefore on the brink of recession. Things are marginally better for the services sector with the services sector PMI at 52.1. The key point is that both the metrics are on a renewed decline after some recovery in the first quarter of 2013. This chart, along with the inflation chart, does strengthen my argument on a fragile global economic activity. In such a scenario, it is very unlikely that the Fed will think of a QE exit.
Specific to the U.S., continued weak retail sales underscore the point that economic activity is slowing down after a healthy first quarter. After a decline in growth in March, the retail sales in April have increased marginally by 0.09%. Also, retail sales (excluding autos) have experienced the second consecutive month of decline. Surely, there are reasons to be concerned for an economy driven by consumption. I must point out here that the QE has done little for the real economy. However, tightening liquidity conditions might impact overall market and consumer sentiments. The Fed would therefore not take the risk of QE exit at this time.
Another important factor, which is closely related to the above factors, is the value of the dollar and its impact on the Fed's decision. The dollar has been relatively strong in the recent past and a weakening economy can result in flow of money in Treasuries and cash holding leading to further strength in the currency. This would be negative for asset prices and exports. The Fed would therefore prefer to continue easing in order to prevent a stronger dollar.
From an investment perspective, the conclusion can be to remain invested in risky asset classes with continued easy monetary policies. However, equities are overvalued at this point in time and investors can wait for some correction before considering fresh exposure. I had discussed the reasons for believing that equities might be in for a correction in one of my earlier articles.
On market correction, investors can consider exposure to the following stocks, which offer an attractive dividend yield.
Johnson & Johnson (JNJ) - is a good long-term investment option. I like this highly diversified healthcare company, with products as well as regional diversification. Further, the sector catered to by JNJ is not very prone to economic shocks. JNJ has been a good dividend payer in the past, with a dividend yield of 3.1%. In my opinion, the stock is excellent for a long-term portfolio. It also commands a higher rating than the U.S. sovereign rating.
Procter & Gamble (PG) - is another good stock in the consumer and personal care segment with a good dividend yield of 3.1%. I must mention here that PG has been an investor-friendly company having returned $88 billion to shareholders through dividends and share repurchase in the last 10 years. In terms of business growth, PG revenue contribution from Asia has increased from 15% in 2009, to 18% in 2012. Also, sales have growth at a CAGR of 23%, 25%, 27% and 17% in Brazil, Russia, India and China respectively in the last 10 years. Going forward, emerging markets will continue to be the growth driver for PG.
BP Plc (BP) - is an attractive long-term buy due to several reasons: excellent and diversified asset base, presence across the value chain, presence in alternative investment themes and a good dividend yield of 5.0%. Further, the P/E is at an attractive level of 6.07. Overall, BP is well positioned to take advantage of the long-term appreciation in crude oil prices.
Apple Inc (AAPL) - can be considered to be a relatively good dividend investment option more than a growth stock option. The stock is currently trading at an attractive PE of 10.8 with a dividend yield of 2.7%, which will improve over the next quarters. Also, with the next line of products to be rolled out in autumn 2013, and in 2014, the stock might consolidate at current levels before the next significant move on product announcement and the market response.