June 1, 2011 / 5:29 PM / 8 years ago

Stern Advice: Prepping your portfolio for the end of QE2

WASHINGTON (Reuters) - Well, the world didn’t end on May 21, as some had predicted.

Xavier Rolet (3rd L), Chief Executive of the London Stock Exchange, stockbroker Paul Killik (3rd R), and Treasury minister Lord Myners (C), the Financial Services Secretary, pose for pictures next to giant woodden letter cubes spelling out "Bonds" in London, February 1, 2010. REUTERS/Andrew Winning

And the sky won’t fall when the Federal Reserve stops its quantitative-easing program, or QE2, according to many financial professionals.

“There’s not going to be a whole lot of effect from the end of QE2,” Jason Ware, an equity analyst for Albion Financial Group in Salt Lake City, said. “It’s been pretty well signaled by the Fed.”

The central bank has been trying to spur the economy by loading up on Treasury bonds since 2008, when it held roughly $908 billion in government securities. Its most recent buying jag, termed QE2, started in the autumn of 2010, and is scheduled to terminate at the end of June. Now the Fed is sitting on some $2.54 trillion of Treasuries, mortgage-backed bonds and other agency debt.

When the Fed starts selling all of those bonds, it would effectively reduce the amount of money and credit that is circulating and keeping the economy growing. And it would also seem likely to result in higher interest rates, as it could take the promise of more yield to sell all those bonds to private buyers.

That’s not going to be good for individual investors, according to a recent Reuters survey of financial professionals. They predicted that stocks, bonds, gold and the euro would all lose value in the three months following the QE2 finale.

But before you sell everything and stuff the cash under the mattress, it is worth considering all that the Fed’s been telegraphing: The central bank has said pretty clearly that it’s going to continue holding those bonds for a while. It is even expected to continue buying enough bonds to replace those that are maturing, so it is not going to be selling aggressively until it’s convinced the economy is strong enough to handle it. Hence the ho-hum reaction of folks like Ware.

WHAT’S A PORTFOLIO TO DO?

So the impending “end” of QE2 may provide some time for investors to decide how to get ready for the true end — that day when the fed starts selling off its stash.

The problem with making those determinations is that experts’ expectations are split between fire and ice. “The end of QE2 will be deflationary,” said Don Martin, a Los Altos, California, financial adviser. “I expect stocks and commodities to decline and bonds to go up.”

But Ed Hyland, an Atlanta-based investment specialist with J.P. Morgan Private Bank, said: “we are poised for higher interest rates and have been for some time.”

Kirk Kinder, a financial adviser with clients in Maryland and Florida, suspects that by the autumn, the Fed will be launching an expansionary QE3 in response to continued economic weakness.

Here are some ways to prepare for whatever:

— Look at history. It may seem counterintuitive for rates to fall and long-term bonds to hold their value or even rise, but that’s what happened when QE1 ended last summer. When the Bank of Japan stopped its own easing plan, the same thing happened, Kinder said. If that pattern holds, there is no need to dump all of your bonds in a hurry now.

— Rejigger those bonds. That doesn’t mean you should bet too much on the continuing decline of interest rates. Bonds are near the end of a 30-year bull, interest rates are bumping along their lows, and so a little bit of protection is in order. Hyland says his company has been recommending more high-yield bonds, which are somewhat less sensitive to interest rate increases. Charles Rotblut of the American Association of Individual Investors suggests that income investors who own individual bonds need not worry about the value of the bonds falling. They can hold them until maturity and cash their interest coupons along the way.

— Watch your stock prices. In the post QE2 environment, economic growth will be weak, and that means some stocks will do better than others, according to Brian Kazanchy, a money manager in Morristown, New Jersey. He is focusing particularly on large cap stocks that are selling at value prices.

— Do nothing? “The danger is that it becomes a guessing game and your forecast could be wrong,” Rotblut said. “It’s a coin toss” as to whether the short-term returns of stocks and bonds will be up or down. He recommends the same-old, same-old: A broadly diversified portfolio that gets rebalanced once a year.

“The smart thing is not to try to outguess the economy,” he says. Most professionals don’t do a very good job of it.”

(The Personal Finance column appears weekly. Linda Stern can be reached at linda.stern(at)thomsonreuters.com)

Editing by Maureen Bavdek

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