How to sail the QE2 investment cruise

November 15, 2010

If only “QE2″ stood for the famous cruise ship Queen Elizabeth II. When she was sailing (she was retired in 2008), you could plunk down a tidy sum, be guaranteed a handful of exotic locales and come back home safely.

Cruising is probably not the appropriate metaphor for the acronym for the U.S. Federal Reserve’s recent QE2 or “quantitative easing,” which will buy at least $600 billion in long-term U.S. Treasury Bonds. It’s an investment voyage of sorts and could be profitable if you concentrate on overseas ports of call.

The Fed hopes that by bringing down interest rates — and indirectly printing money — that the lower costs of doing business will compel U.S.-based businesses to hire workers and stimulate the doldrums-like economy.

I don’t believe that will happen in a significant way, although if I’m a chief financial officer, I will relish the fact that I can sell more long-term debt at low rates. It certainly will help the bottom line of thousands of corporations. As an individual investor, though, I see QE2 as a way of pounding down the value of the dollar relative to other currencies. That may boost the U.S. export economy somewhat, but not if other countries do the same thing or on a bigger scale. (Hello, China).

Nevertheless, investors who hold stocks or bonds from non-U.S. countries can benefit from the relative drop in dollar valuations. Combined with overseas economic growth, this is a trend worth investing in long term as it may take years before Uncle Sam gets on his feet again.

As Standard & Poor’s strategist Alec Young observed in a recent report, “international equities are huge beneficiaries of QE2-induced cross-market trends…a falling greenback boosts dollar-denominated overseas equity returns.” While it’s too soon to tell if this is a long-term trend, the market has embraced the idea of a cheaper buck. The S&P 500 stock index surged 2.5 percent on November 4 in anticipation of QE2.

Are we watching a genuine rally or just short-term optimism that will be dashed by growth that doesn’t materialize in the U.S.? Many economists are saying that if the Fed’s move backfires, it could fuel an inflationary surge, so keep your eye on increases in the producer price index. Commodity prices have been soaring of late, although much of the run-up is attributed to demand in emerging economies.

In the interim, you need to ask yourself if you have enough exposure to non-U.S. equities and bonds. Financial planners generally advise that non-retirees keep up to 40 percent of their portfolio in international shares.

And don’t neglect domestic companies that have large non-US operations or are major exporters like Caterpillar, Intel and Archer Daniels Midland. They will clearly benefit from the dollar decline. (These are not recommendations, only examples).

Even better vehicles than single stocks are mutual funds or exchange-traded funds. They offer low-cost ways of investing in hundreds of stocks and bonds. This is the pick of the litter:

iShares Emerging Market Index ETF (EEM). The fund invests in the top companies in developing countries.

iShares S&P/Citigroup International Treasury Bond Fund (IGOV). A good way to sample bond yields from across the world.

Vanguard FTSE All-World Stock ex-U.S. ETF (VEU). Don’t like U.S. stocks? This world fund excludes them.

As we watch what QE2 does to the U.S. economy, just keep in mind one thing: This is one of the last arrows in the Fed’s quiver. The Fed may not even hit its target or put a dent in unemployment. If the U.S. economy continues to slide, look for more rough waters ahead.

Photo: The Queen Elizabeth 2 reaches the end of her journey as she arrives in Dubai November 26, 2008. REUTERS/Jumana El Heloueh


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