July 25, 2011

If More Stimulus Is on the Way (QE3?), What’s an Advisor to Do?

The Fed has finished its second round of monetary expansion and with the economy seemingly slipping back to a slowerpgrowth posture, don't be surprised if we see a QE3. Prior to QE2, and after TARP, the American taxpayer was not too warm to the idea of another round of quantitative easing. Before QE2 was announced, the Fed embarked on a public relations campaign and released James Bullard, president of the St. Louis Fed, on the media to warn of a 'Japanese style deflationary scenario' unfolding here in the U.S. That seemed to do the trick and the Fed began its second attempt at reviving the economy. That was $600 billion, to be exact! Now that the "stimulus" is behind us what lies ahead? More stimulus, that's what. 

As an advisor charged with the responsibility of watching over clients' wealth, what steps should we take to do this in a prudent fashion? For the moment, the indication for the stock market seems to be that it will go higher, but that could change in a heartbeat. As the end of QE2 was approaching, traders were positioning for a rise in interest rates. Actually, the reverse happened. Interest rates fell, but not because the Fed ceased buying U.S. government treasuries. The reason interest rates fell was due to the fear that reemerged in Europe. Predicting a rise in interest rates was not too difficult to do. However, like it has happened so many times in the past, it's the "wildcard effect" that ultimately determines the outcome. 

Now we have a sluggish economy where consumer demand is weak, business hiring is flat and government spending has been tried and tried with little success. The last component of GDP—net exports—will flourish only if the dollar weakens from here. 

Here's my point. The Fed has shot all of its bullets with one exception and that's to continue to increase the money supply. In other words, get ready for QE3. However, even with QE3, if the consumer doesn't step up to the window to borrow, and banks don't relax their lending standards, all this excess capital will continue to bottleneck in the regional Fed banks and commercial banks. 

Until demand picks up, we will bump along the bottom in terms of economic growth.

What a time to be an advisor! 

Take care and have a great week!

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