More QE on the Way

By Scott Silva

Editor, The Gold Speculator

There is an old saying around Wall Street: “So goes January, so goes the year.” Many traders believe that if the stock market is up in January, then the stock market will finish for the year in the black. Actually, there is some truth to the old saying. Data collected on the S&P 500 over the 65 year period of 1940-2004 show that the broad market closed higher for the year 69% of the time when stocks were up in January. Well, that’s better than flipping a coin, but it is hardly a basis for a successful trading strategy.

Fortunes are made by selecting the best investment compared to others. We have seen, for example, in 2011, stocks fared poorly compared to precious metals, investors in Treasurys lost capital and real estate values continued to decline. Many investors simply gave up and retreated to cash, which turned out to be a losing proposition as inflation cut into purchasing power of every dollar stashed away.

 

But there seems to be a change in sentiment in the air now. Despite massive debt, political gridlock, numbing high unemployment and turmoil abroad, there are some faint signs of optimism. The manufacturing indices have ticked up a bit, productivity has improved and even wages have inched up a bit. Consumer confidence is improving, and corporate profits may bring good news as the earnings season unfolds.

Even the Fed appears to be more optimistic. Last week, the Fed signaled it would hold off on new bond buying (QE3) for now, even though it trimmed its estimates for GDP growth for the New Year.

But not everyone is so sanguine about Fed restraint. Most traders and some economists believe the Fed will step in with another round of Quantitative Easing (QE3) in the first half of 2012. This round would be huge, as much as $1 Trillion and targeted to support the ailing housing market. Under QE3, the Fed would purchase Mortgage Backed Securities (MBS), the derivative instruments that bundle thousands of home mortgages into a single, collateralized package. Many MBS’s were considered “toxic” assets because they contained subprime mortgages that defaulted, making them very difficult to price in secondary markets. When enough MBS’s failed to fetch a bid, mark-to-market rules rendered them worthless, which destroyed many bank balance sheets and created the financial meltdown of 2008.