-The end of QE2 creates a real dilemma

The Fed’s in a pickle. Keep up with QE2, QE3 or another stimulus by another name and risk runaway inflation. End it, and risk the collapse of the economy which very likely cannot stand on its own.

The good news is that there is no real inflation, that being asset inflation. Real estate is dead in the water and will continue to be for several more years, cars cost about the same as they did a few years ago, we’re paying the same for airline travel that we did 10 years ago (albeit with worsening service), computers are getting cheaper and the list goes on. However, it doesn’t feel like that as food and energy scream higher. The Fed likes to remove food and energy from the inflation index, but last I checked, most of us eat and drive.

This has sent the price of oil screaming higher. The worst part is that the turmoil in the Middle East and North Africa is being caused by our QE programs, which I discuss in depth in my The Great Pharaohs Rebellion commentary. This will undoubtedly keep prices under a great deal of pressure and this will further rein in global economic growth. In the US, rising energy prices have absorbed a great deal of the tax cuts enacted last December and have substantially reduced the stimulating effects these cuts were intended to produce. Although it is difficult to estimate, rising energy prices will have a distinctly adverse impact on US GDP; the higher the price of oil, the larger the negative effect. In addition, higher energy prices will spur inflation both at the wholesale and consumer level, which at least in the short run will put additional upward pressure on interest rates.

This is hitting the Consumer Confidence Index hard, as it recently declined almost -8 points to 63.4. Clearly, rising gasoline and food prices are having an impact on confidence. Although consumer confidence is higher than it was in early 2009, at the depths of the recession, it remains stubbornly low at this point in the business cycle, almost two years after the end of the recession. Until we see some improvement in the labor markets and relief at the gas pump, uncertainty will dominate consumer attitudes.

So, from an inflationary standpoint, the stimulus programs must end… but that’s not reality. The real world is that the stock market is addicted to the stimulus and if it disappears, stocks are in trouble. We have to remember that the Fed is not throwing trillions of dollars into this economy because things are good. They are trying their best to get people spending, but most Americans are tapped out.

Given that, I do not expect Quantitative Easing to end. The Fed may say they are going to and stop it to see if the economy can stand on its own. However, that experiment will be short lived just like it was after QE1. At that point we must start to worry about a crisis of confidence, but those always take longer than you would expect.

Although the risks remain elevated, all of this cheap money creates tremendous opportunities. After all, you don’t “fight the Fed”, and low rates are here for a while so take advantage of it. We continue to focus on bonds, preferreds and high dividend paying stocks, many still yielding 8-10%. In addition, our TDT™ Protected Dividend Strategy is tailor made for just this type of market. This will provide great returns with downside protection when the market starts to slide. And of course, we must all make sure we have our personal exit strategy at the ready.

And that’s where we can help. Our active hands-on tactical approach to managing portfolios can help you manage risk and deliver returns. If you would like to discuss the market, economy or simply get a free second opinion on your portfolio, call me for a free consultation today at (916) 925-8900.

Regards –Keith

??P.S. There will be no newsletters for a couple weeks, I will be traveling.