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Stimulating Upside for (Some) Stocks


The tug-of-war between weak economic data and stimulus from central banks is creating a polarized and unpredictable market. Here's how to navigate the next several months safely.

For several months, I've expected the US Federal Reserve to start up a third round of quantitative easing (QE3) before year-end. However, on September 13, the central bank did even more, announcing an open-ended program to purchase mortgage-backed securities at a rate of around $40 billion per month until the labor market shows substantial improvement. The Fed also hinted that it might be willing to expand its purchases to buy Treasuries or other assets as well as mortgage-backed bonds as needed.

This open-ended statement is the first time the Fed has tied its quantitative easing directly to an economic objective-faster jobs creation-rather than setting a specific time and cap on the size of QE. The Fed's balance sheet has already exploded in size from around $600 billion in 2001 to more than $2.8 trillion today, primarily because of its purchase of bonds through two rounds of quantitative easing in the wake of the financial crisis (see the below chart "The Story on Stimulus").

This latest announcement is likely to result in a $500 billion or more additional increase in the Fed's holdings of bonds. This is nothing short of uncharted territory for central banks because never before have global monetary authorities been so accommodative.

I've recommended investors retain a defensive stance due to the rising risk that a combination of weak economic data and the potential for a disappointment out of either the Fed or ECB would result in a significant broader market correction.

I was right about continued weakness for the US and European economies. However, global central banks have delivered the expected monetary stimulus and then some, feeding investors the stimulus they crave and lowering the risk of a significant correction before year end.
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