How the Fed is indirectly helping push up the amount of stock purchases
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How the Fed is indirectly helping push up the amount of stock purchases

  • In September the Fed announced QE3 which consists of monthly purchases of $45 billion of U.S. Treasuries and $40 billion of mortgages. If kept in its current format, these $85 billion monthly purchases will push the Fed’s balance sheet to close to $4 trillion by the end of 2013. How could this affect the stock market? Each weekday the Federal Reserve buys approximately $4 billion of long-term Treasury bonds and mortgages. The Fed buys these securities from dealers (i.e. the major investment banks) by giving the seller a credit on their Federal Reserve statement. By simply changing a number in a spreadsheet, the Fed can create $4 billion in new money. The dealer that sells the bonds to the Fed can then keep the money at its account at the Fed or withdraw the money. With this money the dealer can buy other bonds in the open market. That purchaser then can buy any asset he or she likes with the proceeds. This includes the ability to buy stocks. While it is unknown how much of the newly created money is ending up buying stocks, it is almost certain that some portion of this money is being used for this purpose. By increasing the amount of money on a daily basis, the Fed is indirectly helping push up the amount of stock purchases.
     
  • For the companies in the S&P 500, analysts see profits rising almost 11 percent to over $113 per share for the year 2013.*   For earnings for the 4th quarter of 2012, approximately two-thirds of companies have beaten earnings estimates. For earnings for the 3rd quarter of 2012, approximately three-fourths of companies beat estimates. Corporations set guidance and then analysts use this guidance to project estimates of future earnings. For the past five quarters there have been more corporations issuing negative guidance than positive guidance. Yet, in each subsequent quarter, well over 50 percent of companies beat the average expectation. Corporate executives recognize that they can underpromise in order to make it easier to beat expectations. According to Bespoke Investment Group, there has been an average gain of 0.8 percent on the day of each company’s earnings report for the fourth quarter which has been the best one-day average gain in eight quarters. Earnings estimates for fiscal year 2013 have been lowered over the past year. As explained though, this is typically the case as companies have a tendency to guide lower than would be reasonably expected.
     
  • Over the past 2 months, stocks inflows have outpaced bond inflows for the first time since 2007. With bond yields at near-historic lows, it would not be surprising if investors were investing into other assets that have not performed as well. Yet, this might not be the case. In the first week of February, assets in money market accounts fell by $4.14 billion.**   As Gerard Minack, Head of Global Developed Markets at Morgan Stanley, pointed out, the outflow from equities over the past 5 years cannot explain the massive inflow into bonds during that same time period. However, there have also been large redemptions from money market accounts which could explain the huge move in bonds during this time period. As interest rates on money markets account are close to zero, investors shifted those assets into fixed-income securities that could provide a higher return. This reach for yield has been the driving force behind the continued outperformance of corporate and high yield bonds. As the yields in these sectors are now approaching record lows too, more money from money market funds could soon find its way into equity markets.

*Bennett, Johanna. Are Analysts Too Optimistic About 2013? 18 Dec 2012. Barron’s. 19 Feb 2013. <http://online.barrons.com/article/SB50001424052748704379604578187303980582598.html#articleTabs_article%3D1.>

**Aneiro, Michael. Funds Rotating Into Stocks, But Not Out of Bonds Yet. 7 Feb 2013. Barrons. 22 February 2013. <http://blogs.barrons.com/incomeinvesting/2013/02/07/funds-rotating-into-stocks-but-not-out-of-bonds-yet/>