Quantitative Easing Measures Likely to Help Economy
BlackRock Investment Management
Bob Doll
November 1, 2010
Markets were generally flat last week, with the Dow Jones Industrial Average down fractionally to 11,118 and the S&P 500 Index unchanged at 1,183. The Nasdaq Composite did manage to make some gains, rising 1.1% to 2,507. The upcoming week is unusually packed with market-related events, including the US midterm elections tomorrow, the Federal Reserve’s scheduled policy meeting on Wednesday and the monthly labor market report on Friday, so investors have much to pay attention to over the next few days.
In economic news, the preliminary third-quarter gross domestic product (GDP) report showed that the economy grew at an annualized rate of 2.0%, which was in line with expectations. The numbers show that the economy continues to slowly improve, but is hardly growing at a rapid pace. Looking ahead, we expect that the fourth quarter should see growth levels in a similar range of 2.0% to 2.5%. Beyond that point, easier financial conditions and what seems to be a sustained easing of bank lending standards could help provide a further boost in 2011. As has been the case for some time, the key variable remains the labor market, which has been slow to add a meaningful number of new jobs. On that front, initial jobless claims fell again last week and are now at their lowest level since August 2008, which may auger well for the future.
Despite the mixed economic backdrop, corporate earnings have remained surprisingly strong. At present, over 85% of companies that have reported third-quarter earnings have posted better-than-expected results.
Investors are eagerly awaiting this week’s Fed meeting, where it is expected that the central bank will roll out the long-anticipated next round of quantitative easing (known informally as “QE2”). From an equity markets perspective, we would point out that markets have already climbed significantly since Fed Chairman Bernanke’s August speech that kicked off the series of hints that QE2 was in the pipeline. This probably means that many of the potential benefits of QE2 may already have been discounted by the markets, and investors should not expect to see a major move higher in stock prices as a result of the new easing efforts. In any case, we do believe QE2 should be supportive of modestly improved economic growth by lowering interest rates, furthering the weakness of the US dollar, easing credit conditions and improving confidence levels.
Of all of these likely results of QE2, one that bears especially close watching is the currency issue. Many countries (the United States included) are eager to lower the value of their currencies to boost export levels. As we have discussed in prior weeks, such a scenario poses the risk of escalating into a currency and trade war as individual countries begin to adopt more protectionist measures. We are hopeful that cooler heads will prevail and that such a trade war does not come to pass, but such an outcome is clearly on the risk list.
For the past couple of years, deflationary pressures and deleveraging risks have been front and center in the debate over the future direction of economic growth, and as the pending arrival of additional easing measures shows, these forces are still highly present. Our view, however, is that the worst of the deleveraging situation is now in the past and that the future growth impact of deleveraging will be less than it was over the past two years. Along with the easing of deflationary pressures, the falling dollar, higher commodity prices and the addition of more quantitative easing should prime the pump for inflationary pressures to begin increasing. As such, we believe that the shift from a deflationary to an inflationary environment may soon be on the horizon.
Sources: BlackRock; Bank Credit Analyst. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 1, 2010, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
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Bob Doll is Chief Equity Strategist for Fundamental Equities at BlackRock® a premier provider of global investment management, risk management and advisory services. Mr. Doll is also Lead Portfolio Manager of BlackRock's Large Cap Series Funds. Prior to joining the firm, Mr. Doll was President and Chief Investment Officer at Merrill Lynch Investment Managers.
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