Last night, Federal Reserve Chairman Ben Bernanke spoke to a room of economists - and his tone was much different than it was just a few weeks ago. In late June, Bernanke alluded to the fact that the Fed will begin tapering its $85 billion monthly asset purchases in the near future.
Now, the taper date appears to be further into the future than the market had originally predicted. Here is a direct quote from Bernanke, saying, Both the employment side and the inflation side are saying that we need to be more accommodating. A literal interpretation of the quote tells there will be more quantitative easing (QE) in the months ahead and that the path of least resistance for stocks is higher.
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The $85 billion in monthly purchases by the Fed has helped artificially keep interest rates low and boost stocks. Now that this trend will continue, we need to continue to look at investments that have done well the last couple of years. There are three areas I am focusing on with the continuation of QE.
Stocks are the most attractive asset class with interest rates well below historical averages, good valuations, strong charts and the Fed on their side. Within the asset class, leaning towards the aggressive stocks leads to the iShares Russell Microcap Index ETF (NYSE:IWC). The ETF is a basket of over 1350 micro cap stocks that trades with a slightly higher beta (volatility) of 1.19 versus the S&P 500.
The one issue with IWC is that it is trading at an all-time high and therefore waiting for a pullback is the best strategy. Patience may pay off in this situation.
Income-producing ETFs are another area that should continue the trend of moving higher with the cooperation of the Fed. As the Fed buys more bonds, it keeps interest rates low, which in turn makes the yields of dividend-paying stocks even more attractive. The iShares High Dividend Equity ETF (NYSE:HDV) is a basket of 75 mainly large-cap stocks that pays a 3.6 percent dividend yield.
The ETF over five percent from its highs during the sell-off, but has since rebounded and is catching a bid after investors realized the Fed was not done pumping up the economy. The combination of high income and a basket of large-cap, stable companies make HDV an attractive opportunity.
Finally, there are bonds themselves that should benefit from the Fed keeping interest rates low. The price of a bond and interest rates have an inverse relationship. As interest rates increase the value of bonds decreases and vice-versa. With that being said, investing in US government bonds is too risky.
The play here is with corporate bonds that have below investment grade ratings. The ETF is the SPDR High Yield Bond ETF (NYSE:JNK), which is a basket of over 600 corporate junk bonds that is yielding 6.1%. Even when interest rates begin to rise again, JNK should be able to outperform treasuries and when stocks are increasing, junk bonds will often follow the market trend.
There are of course many other ETF options available to play for a prolonged Fed involvement in the economy. However, the three above offer a diverse starting point that should fit most investors long-term goals.
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