#2 What Worked in 2012

Posted on January 20th, 2013

The #2 investing strategy for 2012 was following the Fed. It’s no surprise that if one could recognize what the Fed was doing this year you could ride their wave of QE to success. 
We posted on September 13th a chart that illustrates how the market has traded during the periods when the Fed was executing their quantities easing program titled: Some of the Impacts of QE So Far. The highlight was the chart below that showed the S&P500 price chart performance over the periods when QE was active. That pattern continues to show strength as the market rallied into the end of the year despite the election pull back and fiscal cliff fears.
Arguably, the main beneficiary of QE was fixed income. It was #3 on our list of things that worked and the only item we’ll add in this write-up is the dropping of mortgage rates because it finally had an impact on the housing market as we’ll explain below.
Once the Fed started purchasing bad mortgage based debt, two sectors immediately benefited. The first was the financial sector as their risks immediately lowered. The second was the home builders as lower mortgage rates finally had the impact Chairman Ben was looking for. Comparing XHB (Home builders ETF) and XLF (Financial sector ETF) to the S&P tells a pretty compelling story.
Two areas that have yet to see the full impact of QE are inflation and currency. The theory is that if dollars continue to pump into the system the US Dollar will weaken and inflation will rise.

The Fed has already said it has a target inflation of 2% and is willing to let it go a little higher if it means lowering unemployment. So far, inflation has not reared its ugly head; and ugly as it may be, there are ways to profit from it. Vehicles like the TIP (Treasury Inflation Protection ETF) or Gold have yet to pop as expected in the 4th quarter. There may still be time to get in on those inflation trades. Also, the US Dollar weakening will provide some opportunity against currencies that are not easing as quickly as the US is.
2012 was a good year for the Fed, but the consequences of its actions are still yet to be determined.  We continue to tread in uncharted waters and many naysayers warn of the long term effects on the future of the US economy and markets. While that may be true, it’s hard to argue with the results so far. 

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