QE2 Sets Sail
Every financial person in America is caught up with the implications of QE2 – the oh-so-cute name attached to the second round of “quantitative easing” by the Federal Reserve Board. At the same time, the average investor remains fairly clueless as to what impact, if any, this move will have on his or her portfolio.
First some background. In early November the Fed announced it would, in an effort to stimulate the economy, buy $600 billion in long-term Treasuries over the next eight months. The Fed also announced it would reinvest an additional $250 billion to $300 billion in Treasuries with the proceeds of its earlier investments. The whole process is to be completed by the end of the third quarter of 2011.
I’m not equipped to argue whether or not this vitamin shot will have the desired effect; brilliant minds are arguing all sides of that issue. What I can do is give you a glimpse into how Jack Bowers and I think the Fed’s action will affect mutual funds held in our clients’ accounts.
Over the past three weeks our favorite high-yield mutual funds, Fidelity Capital & Income and Fidelity Strategic Income, were both pushed down by, among other things, worries about the Irish debt and whether that contagion will spread. However, QE2 is actually a plus for the high-yield sector because, we believe, higher inflation makes it easier for heavily-indebted companies to manage their debt. After all, those firms get to pay back what they owe with ever-cheaper dollars. And yes, the Fed made its move in part to bring inflation back. Sounds strange, but inflation is seen as much more desirable than its evil twin, deflation.
As for another mutual fund we currently hold in some of our conservative accounts, Fidelity Total Bond, we see QE2 as having a neutral-to-positive effect. Total Bond has a duration of about 4 (duration is the weighted average term to maturity of a bond’s cash flows), putting it in position to benefit from the Fed’s actions. Conversely, a fund like Fidelity Corporate Bond has a much longer duration, which augurs against much benefit as the Fed begins buying Treasuries.