COLUMN-Hedges for investing in a post-QE3 environment

Fri Sep 14, 2012 12:17pm EDT

By John Wasik

CHICAGO, Sept 14 (Reuters) - The Federal Reserve's new round of quantitative easing may have sparked as much early enthusiasm as the opening of a new fall fashion show. Yet as with other ballyhooed events, the initial warm reception may prove fleeting.

The Fed's latest buying spree of Treasury and mortgage-backed securities will keep U.S. interest rates low and drop them incrementally lower. And Wall Street initially cheered the Fed by propelling both the Dow Jones industrial average and the S&P 500 Index to their highest levels since 2007 on Thursday. The once-battered Nasdaq Composite Index even climbed to its highest level since November 2000.

On the employment, manufacturing and housing fronts, though, there is only so much the Fed can do to revive those markets - and it will do nothing to fix the euro zone - so don't take Thursday's rally too seriously. By adopting a tandem strategy of targeted hedging and global investing, you can still ride out continuing anxieties in Washington and Europe. And there are side effects to this stimulus, too. So if you are looking for investing strategies, you might want to employ some of these hedges:

1. Think inverse

Fed easing typically means the dollar's value against other currencies is likely to drop and commodities including precious metals will gain. If you are concerned about further hits to the buck, there is something you can do about it. There is an "inverse" exchange-traded fund for the dollar, the PowerShares DB US Dollar Index Bearish ETF, which uses futures contracts to short the dollar. Gold also does well when the greenback sinks. Consider the SPDR Gold Trust, which holds gold bullion and tracks the price of the metal fairly closely.

Note: these ETFs are complex and volatile vehicles that should be used only if you need to protect your portfolio against large currency swings. Currencies and metals are notoriously difficult to predict; never think you have the ability to successfully time this market.

2. Bet with your head, not over it

Since it is always difficult to bet against something - you need a trader's steely nerves to know when to get in and out - it is a much better strategy to invest for long-term appreciation. Financial service companies certainly will relish and profit from the low Fed rates for a few more years, barring another derivatives-fueled calamity. Consider the iShares Dow Jones US Financial ETF, which holds financial giants such as JP Morgan Chase & Co, Wells Fargo & Co and American Express Co.

3. Think international

The Fed stimulus also bolsters the balance sheets of large multinational companies. If you are a corporate treasurer, this is a great time to keep borrowing at some of the lowest rates in a generation, expand into more global markets and invest in research and development.

The Vanguard Mega Cap 300 Index ETF provides a sampling of the largest U.S.-based companies such as Apple Inc , Exxon-Mobil Corp, General Electric Co and Procter & Gamble Co. Most of these companies are cash-rich and have a growing global presence.

4. Beware of politics

What could derail the first-blush QE3 euphoria is the inability of Congress and the White House to come to terms on the looming fiscal cliff, when U.S. taxpayers may get hit with about one-half trillion dollars' worth of tax increases resetting from Clinton-era levels on Jan. 1. The Fed's actions will have no direct impact upon Congressional logjams.

Falling off the cliff will be perilous for the struggling U.S. economy, possibly even triggering a recession if Congress does not act. The situation is so threatening that the Congressional Budget Office recently estimated that some 2 million jobs will be lost and U.S. economic growth will be pinched by nearly 3 percent if all the tax increases on income, dividends, capital gains, payroll and estates go into effect. The ratings agency Moody's also threatened to lower the top credit rating for the United States if its even larger budget issues are not resolved soon.

While the Fed's program to buy Treasury and mortgage securities may be bullish for big borrowers and lenders, it is likely to have little impact on household wealth, especially if there is no strong rebound in housing. The Obama administration has yet to announce what it plans to do with Fannie Mae and Freddie Mac, the two quasi-public mortgage companies that account for the lion's share of new mortgage volume. Freddie and Fannie were seized by the U.S. Treasury in late 2008 during the financial meltdown.

What you will need in great supply is patience, as it appears that none of Washington's fiscal perils will be resolved soon. Congressional observers see little, if any, meaningful action on budget or tax issues before the Nov. 6 election. Europe is still a work in progress. In the interim, anxiety over this widespread uncertainty will continue to roil the markets.

The ensuing uncertainty still works in your favor, though: It is a good time to add to your portfolio durable stocks that will do well no matter who is in power next year.

Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.