The Federal Reserve announced on September 13th, 2012 that it would purchase $40 billion of mortgage-backed securities, and the market responded by rallying around 1.5%. This rally once again illuminates the attitude of the majority of capital within the equity markets and demonstrates the public's current proclivity towards stimulus. As a trader, my role is to assess the situation objectively and trade the market accordingly. As a direct way to trade the market, I utilize both the S&P 500 ETF (NYSEARCA:SPY) and when the market is strongly trending, I rely on Direxion's 3X ETF (NYSEARCA:SPXL).
Quantitative Easing and Velocity of Money
I fundamentally do not agree with the Federal Reserve's decision to continue quantitative easing. Quantitative easing is basically printing money to decrease the rate on yield-bearing assets. As the Federal Reserve purchases these assets, the yield on these assets decreases which (hopefully) trickles through the economy allowing businesses and individuals to take out credit at favorable rates. The hope of the Federal Reserve is that through decreasing the yield on assets, businesses and individuals will respond by utilizing credit to drive business and consumption. This theory is sound if money actually moves about within the economy. If individuals are not interested in purchasing or businesses are not seeking to invest, they more than likely will not seize upon the opportunity afforded by low yields. A method of measuring if this money is actually moving about in the economy is velocity of money. The chart below shows the velocity of money since the financial crash of 2008.
No matter which way you examine it, money simply isn't moving about within the United States economy. What this essentially means is that the Federal Reserve's efforts to continue decreasing the yield on assets currently will not transcribe into higher levels of consumption and business activity. Sure, individuals can take out loans at historically low rates, but according to the past few years of data, they are actually less likely to move that money back through the economy as time progresses. This decrease in velocity signals that the current quantitative easing program is more than likely not going to fix the current economic situation.
All investors are well aware of the government deficit and debt levels, which by many accounts, are unsustainable. The government deficit arises when its inflows of tax revenue are less than its outflows of expenditures, and this figure is currently rising. The chart below shows the historic trend in the government deficit for the past 12 years.
Since government deficits are financed by the debt markets, it is very obvious that higher levels of debt are in store for the United States. As the United States incurs greater level of debts, a higher percentage of government revenues must be spent on financing its fixed income obligations. In the long run, if the United States does not address this debt issue, I believe that these expenditures could cause a significant drag on the economy as higher taxes are required to pay the coupon payments of the United States debt.
As the chart above shows, the United States debt burden is increasing at an exponential rate. This increase is disheartening to say the least. Future generations of Americans will be required to deal with crippling debt levels if action is not taken.
And Yet I'm Long
Despite the fundamental picture of the United States, I am long the S&P 500 through Direxion's SPXL. The trend is upwards and it makes very little sense to argue with the market. The mortgage-backed security purchasing program announced by the Federal Reserve does little to help the economy in my opinion, but my job is to trade on fact, not emotion.
The markets have rallied 80% from the lows of 2009 and the trend has shown no signs of reversing. Technically speaking, all investors should be long the market despite their feelings about the state of the economy. The market is not a voting machine in which the masses decide the winners and losers, but rather it is a weighting machine in which the quantity of money is the sole arbiter of price. The market has cheered all of the quantitative easing programs announced by the Federal Reserve, despite their failure to significantly generate jobs or promote growth. For this reason, I am long the market. I would rather be upset at the monetary situation of the nation and earning a return on my investments than upset and losing capital. As the chart below shows, the market is heading upwards and short positions are getting hit hard.
In order to capitalize on the QE3-fueled rally that I believe will occur over the next few weeks or months, I have chosen to be exposed to the triple-levered ETF SPXL. As long as the S&P 500 continues its upward march and the SPY stays above $143, I see it as entirely appropriate to be long the market.