This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.
In my last post, I explained that 'Quantative Easing' isn't really money printing per se, but rather an asset swap - you're exchanging long term bonds for cash. In the process, they've driven down long term interest rates to historical lows.
For the last few years now, The Federal Reserve (the central bank of the U.S. with the authority to print money) has been buying up long term debt at the pace of $85 billion per month.
That's a lot of dough.
On June 19th, the Federal Reserve (i.e. the 'Fed') released a statement, and said that it could begin to reduce the amount of bonds it buys. In Wall Street, they're calling this the 'taper', as in tapering its bond purchases. This sent the financial world into a shock. It plummeted almost every financial asset out there. In this article, we examine the effects of the taper on 5 major asset classes.
1. Bonds
The Fed purchased long term bonds to artificially inflate its prices. With the expectation that the Fed will no longer prop up its price, Wall Street traders began dumping bonds. As a result, bond prices have been going down, and interest rates have been moving up.
2. Stocks
Corporations have been taking advantage of the low interest rates to borrow money and buy back their stock. This led to fewer numbers of stocks outstanding. Whenever there's less supply of something compared to its demand, prices go up. This has been partly responsible for the run up in stock prices for the past couple of years.
A higher interest rate also discourages people and corporations from borrowing, which means that they will spend or invest less. As a prime example, think about mortgages. You're less likely to get a mortgage if the interest rate on the mortgage goes 0.5% higher. This hurts spending, which hurts the economy, which hurts stocks.
3. Gold
Okay, so no one who takes advice from me will have invested in gold. Still, plenty of people have invested in gold, so let me talk about it.
Many people held gold because they felt that the Fed's 'money printing' will increase inflation. Well, that hasn't happened at all, and if you understand the true nature of Fed's operations, you understand why.
However, many gold bugs still held out hope that inflation will still come, but it never materialized. Now, with the Fed potentially paring back its bond purchases, the gold bugs are giving up. This is sending gold prices down.
4. Emerging Markets
Emerging markets like China and Brazil have been tanking. When U.S. interest rates were very low, investors looked outside the U.S. for investment returns. This appreciated emerging market stocks and bonds.
Now, the process is reversing and all that money is coming back to the U.S.. As per usual, when trouble happens in the U.S. emerging markets get hit much harder than the U.S.. This time is no different.
5. The Loonie
Many of these emerging markets are resource hungry. China alone accounts for 22% of world copper demand, and 60% of world iron ore demand.
As the economies of these emerging markets slow down, they will need less of these commodities. That means less demand for Canadian natural resources, which means less demand for the loonie.
A higher interest rate in the U.S. also makes holding U.S. debt more attractive, so some investors may have dumped long term Canadian bonds, exchanged their loonie for the U.S. dollar, and bought U.S. debt. They may have also done so because they see a potential crisis, and in a time of crisis, U.S. dollar always wins.
What can you do about it?
In summary, U.S. bonds, U.S. stocks, Canadian stocks, Canadian bonds, gold, emerging market stocks and bonds, and yes, even our loonie has been tanking relative to the almight U.S. dollar.
Unfortunately, there's really no way to be completely immune from the damage. Putting money under the mattress is one of the worst things you can do.
The markets are unpredictable. What went down yesterday may go up by a lot tomorrow. The best thing you can do is poise yourself for a rebound, while at the same time limiting any potential damage.
If you don't mind me shamelessly advertising, this is where our membership portfolios truly shine, as they've been designed to limit the damage without sacrificing potential returns through the use of sophisticated algorithms. If you have a financial advisor, compare us! Look at your monthly returns compared to our membership's, and see how they stack up.
This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.
