QE Can Create Jobs
Fed watchers know that Janet Yellen has a very proactive stance relative to monetary policy's role in helping the Fed meet their full employment mandate. Her stance will impact currencies, ETFs, and portfolio allocations. From Bloomberg:
As the Fed's No. 2 official, she has articulated the case for maintaining highly accommodative monetary policy. In a series of 2012 speeches, she outlined why rates could remain near zero into late 2015, and in a 2011 speech she justified the Fed's first two rounds of large-scale asset purchases, known as quantitative easing or QE, with an estimate that the programs would create 3 million jobs. Yellen isn't among the Fed policy makers who have pressed this year to pare back asset purchases.
Yellen's Tailwind For Emerging Markets
When Ben Bernanke let the tapering cat out of the bag in May, it was harmful to emerging market currencies and stocks. QE is a politically correct term for pure money printing. When the Fed adds to the supply of U.S. dollars floating around the globe, it makes foreign currencies more attractive on a relative basis. From Yahoo/CNBC:
Now that Janet Yellen is expected to be Fed Chair, the prospects look dimmer for an early tapering of QE. That means US Treasury bonds will continue to be bought, lowering interest rates, and making emerging market currencies relatively more attractive. And, it makes emerging markets more attractive in general given their risks.
What About The Debt Ceiling?
If you want to find ETFs that will beat the S&P 500, a good place to start is by examining ETFs vs. the S&P 500 on charts. The list on the right margin represents a tug-of-war between Yellen-ETFs and fear-related ETFs. ETF performance relative to the S&P 500 this week is being led by the short/inverse U.S. stocks category (dark red). The second layer of risk-off ETFs comes from the domestic bond category (light red). Risk-on leadership fits nicely into the Yellen theme, with emerging markets (dark green) and foreign developed stocks (light green) dominating.
It is unlikely that all four major categories to the right will continue to lead in unison. If the debt ceiling talks continue to drag on, risk-off will continue to carry the day, which will call for some patience with the Yellen-themed ETFs. If the dysfunctional political system can find a way to improve Congress' ridiculously low approval ratings, the first place we will consider redeploying some of our cash is in the emerging markets (EEM) and foreign developed (EFA) spaces.
No Tangible Signs Of Progress
While we will keep an open mind about the path of events in Washington, it is difficult to see 100% smooth sailing during the upcoming talks on the debt ceiling. The recap of Wednesday's events does not point to an imminent breakthrough. From Reuters:
With pressure rising and no clear path forward for breaking their fiscal impasse, President Barack Obama launched a series of White House meetings with lawmakers on Wednesday to search for a way to end a government shutdown and raise the debt limit. The depth of the dispute was evident, however, in the failure of Obama and House Speaker John Boehner to even agree on a guest list for their Thursday session. There were no tangible signs of progress on Wednesday, although some members of both parties floated the possibility of a short-term increase in the debt limit to allow time for broader negotiations on the budget.
Bonds Are Trying To Overtake U.S. Stocks
Regular readers know the three steps required for a bullish trend change. If you are new to the fold, this identifying trends primer is worth a look. The chart below tracks the demand for bonds (AGG) relative to stocks (SPY). When the ratio is rising, demand for bonds is greater than the demand for stocks (aka risk-off). Bonds have completed two of the three steps required to establish a bullish trend vs. stocks. Step three requires the ratio below to close above the pink line this week, which would establish a higher high. The weekly battle between economic concerns and economic conviction still has two trading days left.
How About Emerging Markets vs. Bonds?
The chart below tracks the demand for EEM relative to AGG, or a diversified basket of U.S. bonds. The picture favors EEM from a weekly perspective, but shorter-term it is more of a mixed bag. Points A (higher high) and B (clearing a trendline) are bullish for EEM. Point C shows a lower low this week, which is indicative of hesitation on the part of ETF buyers. Hesitation seems logical given the clown show taking place in our nation's capital.
Investment Implications - Booking U.S. Profits
Our market model has called for numerous chess moves to reduce exposure to stocks in recent weeks, including booking some nice profits in U.S. tech stocks (QQQ) Wednesday. In the table above, no U.S. stock ETFs made the cut, which means when the political skies clear, there may be better places than QQQ for our limited capital.
When The Evidence Shifts Toward Bulls
Prior to redeploying cash, we need to see an observable shift back toward the risk-on/economic confidence camp. If the bond vs. stock ratio above clears the pink line this week, we will be more apt to continue with a risk-reduction strategy. If investors see signs of progress on the debt ceiling front and the AGG vs. SPY ratio begins to retreat again, our short list of buy candidates will include ETFs in the emerging markets and developed foreign stocks categories in the table above.