Oh what a difference a week makes. Just one week ago President Obama had virtually no way out of the mess he was about to create in Syria. But then on Monday, Russian leader Vladimir Putin gave him one. Putin is no fool. He knows that many Americans vehemently oppose U.S. military action in Syria, and that Congress and the President were vulnerable to acquiesce. A deal was then orchestrated and brokered by Russia to remove Syria’s chemical weapons peacefully.
And “the market” breathed a sigh of relief. The Dow Average rose 3% on the seemingly positive news – but stock market strength and gold both lost ground, -2% and -5% respectively. Why?
It is widely expected that the Federal Reserve will announce the commencement of terminating its controversial quantitative easing (QE) program in their next meeting slated for later this month. The Wall Street establishment will hate that news and immediately send stocks lower and yields higher – but that wasn’t on their minds this week.
Many people still don’t understand the QE dynamic, and as a result, they don’t really grasp the effect of its termination. For instance, some interpret the termination of QE as a strengthening event for the U.S. dollar. They see a decreasing amount of new dollars injected into the system will “strengthen” the dollars already in circulation – and as we know, a strong dollar environment will cause gold to fall. That appears to be the bet gold traders placed this week.
And it was a sucker bet. Terminating QE does not automatically create a strong dollar environment.
To put it simply, QE is the process of printing new money and handing it to Wall Street investment banks. Investment banks then use half of that money to purchase U.S. Treasury securities (this to create additional and new demand for bonds which helps keeps their yields low), and the other half of the new money is used to sustain Wall Street’s operation by increasing capital reserves and their investments in marketable securities (which helps drive their profits and broader market stock prices higher.)
The net effect of QE to the American market is artifically lower interest rates and theoretically stronger investment banks – not necessarily a stronger dollar or market economy.
However, terminating QE can weaken the economy because monetary incentive to keep yields low and stock prices high will end. Higher yields (due to lessening bond demand via QE) will make obtaining loans even harder. This will slow the economy further, and because investment banks will have less free money to profit from, stock prices will have more reason to correct.
The stock market does not move with unfounded mystery. Indeed, timing the specific day and the certain amount of correction is impossible to predict. Thankfully, those criterions are not required to invest successfully.
When “the market” trades at irrationally exuberant valuations many unskilled investors feel as if they’re missing something, and feel compelled to buy at the absolute worst times to invest. Buying high and panic selling during dramatic market sell-offs is not cliché, and it’s not the way to make money.
People always ask me when to buy and how much to buy at any given time. These are personal decisions. We all have different goals, different portfolios, and different risk tolerances and allocations. That’s okay. It’s what makes the world go ‘round.
Making money through marketable securities is the process of earning a desired return for an appropriate amount of risk. My book provides step-by-step instructions of how to create an investment plan that will achieve your financial objectives. That is to say that a plan, not perfect timing, is required to achieve above average investment performance.
For example, the chart below shows investment activity since the Dow’s previous all-time high (October 2007) until the present. In that time span the 15-51 strength Indicator produced a 78% gain while the Dow Average advanced just 9%. See below.
Clearly, long-tem investors with above-average portfolios could have profited significantly by investing in what can be considered nothing short of a terrible time to invest; after all, it was the market high just one year before the financial markets collapsed.
However, if alert investors had the patience to wait for correction to occur before investing they would have more than doubled their return. The chart below shows investment activity from the last “market bottom” (February 2009) to now. Please note that February ‘09 was not the 15-51 Indicator’s bottom, as it went lower just as the chart begins.
During this time span the 15-51 Indicator gained 198% compared to the Dow’s 118%. In this case risk was mitigated significantly because the “buy” point occurred at a much lower valuation. The gains incurred during the previous chart came at a much higher price point, at a much riskier time, and produced less reward.
And who didn’t see the last major correction coming?
I was writing my book at that time and fully expected another “tech bust” type correction. Worse came for sure (that’s also detailed in the book) but that price correction was fully expected by many independent analysts, including me.
Indeed, money can be made in all types of markets. However, irrational exuberance always sells off. Always – QE or no QE. So why buy into it?
That said – and when deciding how much stocks you should own, buy, or sell – the most vital questions to ask yourself are: How much capital do you want at risk?— How much profit do you want to make?—and, What is your time horizon to make that money?
Plan your work and work your plan – and let me know if you need help.