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It’s the first week of September and professional investors in Europe and the U.S. return from holiday and the Labor Day weekend facing a minefield of potentially market-moving events in September.
Here are just a few of the headline-making events investors have to look forward to in the weeks ahead:
Today: European Central Bank (ECB) policy meeting. An expected interest rate cut and details about a potential ECB bond-buying program.
These macro-events, coming one right after another, are sure to add more volatility into the mix.
On top of that, September has typically been a difficult one for markets. Buckle your seat belts!
Click the chart for a larger view.
Judging from the historical record, September is the only month of the year when stocks show a significant decline (average — 0.8 percent). And monthly returns have been negative almost two-thirds of the time. Plus, October has also included some high-profile market declines.
With downbeat seasonal trends setting the stage, the real spotlight is on Europe, where ECB finance ministers are still trying to agree on details for a bond-buying program.
The hope is to reduce sky-high interest rates for over-indebted countries like Spain and Italy, but the ECB is meeting stiff resistance from Germany. The problem is no matter what progress the ECB reveals this morning, it could all be undone by the German Constitutional Court next week!
You see, the German high court is set to rule on the very legitimacy of the ECB’s European Stability Mechanism (ESM) by next Wednesday.
This is the proposed conduit through which the ECB hopes to purchase some 500 billion euro worth of bonds to “stabilize” European markets and bring down interest rates.
In short, if the ECB is unable to deliver on Mario Draghi’s pledge to “do whatever it takes” to find a solution to this crisis, or if Germany overrules the plan next Wednesday, volatility could skyrocket.
Closer to home, the next big market moving event begins on the same day when the FOMC has a two-day policy meeting scheduled for September 12 and 13.
There’s been plenty of discussion in the media about the potential for QE3, or more quantitative easing (i.e. money printing) from the Fed at next week’s meeting, so I won’t rehash the details here.
Suffice it to say that Ben Bernanke still holds to his belief in the effectiveness of QE and he appears to have the FOMC votes needed to launch another round — “as needed to promote a stronger economic recovery and sustained improvement in labor market conditions” — just as the Fed has been saying right along.
Rather than trying to handicap the odds of more quantitative easing being announced next week … or perhaps later this year … let’s instead take a look at how markets have reacted to quantitative easing in the past — for clues about future direction.
Click the chart for a larger view.
The chart above shows the stock market’s reaction to QE1, QE2, and Operation Twist (blue shaded areas), the Fed’s three large scale asset purchase programs to date. Just as expected, the S&P 500 Index has gotten a nice boost from all three rounds of quantitative easing …
QE1 (3/18/2009 — 3/30/2010): +50.8 percent
Although not displayed in the chart above, the Fed’s forays into quantitative easing have generally had a positive impact on commodities, as measured by the CRB Continuous Commodity Index (CCI) …
Only in the case of Operation Twist has Fed stimulus not resulted in a gain for commodity prices, at least not yet anyway. But recently gold and oil have been playing catch up, moving substantially higher since June.
Another explanation for the lack of a commodity boost from Operation Twist is that the Fed isn’t actually expanding its balance sheet this time around (i.e. printing new money), but is only extending the maturity of its existing portfolio of securities.
Contrasting the upside move in stocks and commodities, this next chart shows the impact of QE on 10-Year U.S. Treasury yields, and it’s just the opposite.
Click the chart for a larger view.
Notice how each time the Fed launched QE, Treasury yields rose to higher levels during the period when the Fed was in the market buying securities.
This opposite reaction in the bond market might seem puzzling at first glance, because a stated objective of the Fed has been to hold down long-term interest rates to promote economic growth and job creation.
Granted, Treasury yields have indeed fallen over the entire period since 2008, so the Fed can claim mission accomplished. But they have moved in exactly the opposite direction each time the Fed purchased securities with interest rates moving consistently higher.
When you think about how Wall Street operates, this reaction makes more sense.
After all, the Fed has consistently telegraphed its intentions prior to each round of easing in the past. All the primary dealer-banks the Fed trades with know when they see a great trading opportunity coming a mile away — especially when Uncle Sam is on the other side of the trade.
The big banks essentially front-run the Fed’s bond purchases — by snapping up Treasuries in advance of the expected announcement — hoping to unload the securities at higher prices a short time after the Federal Reserve Bank of New York starts buying!
Massive bond selling by the primary dealer-banks and other investors into the Fed’s open arms has ultimately driven bond yields higher during past episodes of QE. And I expect Treasury bond yields to move higher all over again should the Fed engage in more quantitative easing.
Bottom line: Whether the FOMC announces QE3 next week, or perhaps some time later this year, we’re likely to get the same market reaction this time around as we witnessed after the last three rounds of QE. Stock and commodity prices could enjoy a lift as bonds prices get hit with yields moving higher.
Good investing,
Mike Burnick
P.S. My International ETF Trader members are already profiting from the rise in gold prices and the drop in Treasuries. To learn how you can join them — RISK FREE — and receive my recommendations sent to your computer, iPhone, iPad, or cell phone, click here.
1QE1 is dated from the start of the second phase of Large Scale Asset Purchases, the first phase began on 11/25/08. QE2 is dated from Ben Bernanke’s speech at Jackson Hole conference; operation began on 11/3/10.
Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.
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Right. so there’s going to be a rally according to you and a collapse according to Martin and Mike. .