If Investors Get More Stimulus, Will They Take More Risk?

The U.S. economy continues to show signs of frailty. U.S. gross domestic product (GDP) expanded at a feeble pace of just 0.7% in the 4th quarter. In the same vein, the Atlanta Fed’s GDP forecast for the first quarter of 2016 is just 1.2%.

There’s more. The manufacturing segment of the economy has contracted for four consecutive months. Meanwhile, year-over-year growth for total business sales as well as retail have steadily eroded. Also, year-over-year activity for corporate spending on tangible assets like equipment, buildings and machinery (i.e. capital goods) has decelerated, ultimately turning negative.

Deceleration Across The Board

Throughout the course of the current bull market cycle, investors have relied on the Federal Reserve to stimulate the economy as well as risk asset appetite. The central bank of the United States bought mortgage-backed securities and U.S. treasury debt in the beginning of 2009 (a.k.a. “QE1″). When the economy softened in 2010, the Fed rode to the rescue in 2010 with “QE2.” When the euro-zone crisis threatened the world economy in 2011, monetary policy leaders acquired longer-term Treasury securities with the proceeds of shorter-term debt to push borrowing costs even lower. The media dubbed the new stimulus effort, “Operation Twist.” And economic deceleration in 2012 led to the most remarkable stimulus of them all, “QE3.”

GDP historical

What is strange about the picture above? In December of 2015, the Federal Reserve raised its overnight lending rate by 0.25%, even though the U.S. economy had been showing signs of strain. The stimulus removal may not have seemed like a big deal at the time. However, the Fed’s expressed desire to move in the direction of less stimulus has significantly impacted currency exchange rates, corporate bonds, foreign bonds, and investor tolerance for risk.

Consider a few straightforward realities in the ETF world. Since the last bond purchase of QE3 in mid-December of 2014, CurrencyShares Euro Trust (FXE) has depreciated 11% and PowerShares US Dollar Bullish (UUP) has appreciated 8.5%. Similarly, FXE is near a 5-year low, while UUP is near a 5-year high. CEOs of U.S. corporations regularly cite the super-sized strength of the U.S. greenback as a severe headwind to profit growth.

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Disclosure: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered ...

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