Thursday, June 20, 2013

Quantitative Easing - how it affects the economy and the stock market?

A 2 day fed meeting ended yesterday with US federal reserve chairman Ben Bernanke concluding the meeting. This is a very important news every investor was waiting for as it determines the next step of action for most investors.

So why was it so important? The discussion was on the hot topic for many years: QE. Quantitative easing or QE is a bond buying program that the fed has been implementing for the past 3 years. They will go into the open market and buy up bonds in an effort to keep interest rates in the economy low. A lower interest rate stimulates more loan lending activity and thus provides ample liquidity in the economy.

However, yesterday, fed chairman Ben Bernanke said that: "The Fed will probably taper its $85 billion in monthly bond buying later in 2013 and halt purchases around mid 2014 as long as the world's largest economy performs in line with Fed projections". (Quoted from bloomberg news)

The Fed also said that it is confident that unemployment will lower down to 6.5% soon. Currently unemployment in the US is still above 7%. With such strong words, the market got a clear direction and sold off aggressively wirh the Dow Jones index declining 200 points. Asian markets are selling off also at the moment with most asian indices declining more than 1.5% and STI declining -68 points currently.

Interest rates
With interest rates expected to rise later this year, banks,  property stocks and reits are the most affected. Reits and property stocks have already sold off 2 weeks ago and is still on a decline currently. As interest rates rise, loans become more expensive causing lending activity to decrease. Reits have already sold off around 15-20% the past few weeks mainly because institutions like goldman sachs are selling. Why are these institutions selling off? The reason is most institutions borrow money at low interest rates to buy into reits with high yields. This is called a carry trade. As interest rates rise, the value of yield asset reduces as institutions have to pay higher interest rates.

Opportunity is here
My view on this is that the sell off is an opportunity to pick undervalued stocks at a bargain. Interest rates will only rise when the economy starts picking up. It is actually good news but the market sees it as bad news because we have been so reliant on a low interest rate environment for many years. Since we know that the market is always irrational in the short term, this gyration now presents a perfect opportunity for investors who know how to pick companies to buy.

As the economy recovers, cyclical stocks like shipping, industrials and banks will perform well. Most of the sectors that have underperformed in times of low growth will start picking up from here. During recessions and periods of low growth, defensive stocks like medical, telcos, reits tend to outperform the rest. Now the tide is changing.

As the US economy recovers, import and export activity will start to increase. This will benefit shipping companies greatly and many will turn to profit from loss currently. Dry bulk shipping has seen shipping rates picking up as the baltic dry index (BDY) gradually increases from 790 to 995 currently. The index was at a high of 9000 before the financial crisis in 2009.

Apart from the economic news, the main news that encompass our lives in Singapore now is the haze condition. For the past 3 hours, the PSI reading has been above 300. Please take care of your health and stay indoors as much as possible.

One more day to the weekends. Have a great week ahead and invest safely!

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