Who Stands To Benefit From QE2?

By Stephen D. Simpson, CFA | November 23, 2010 AAA
Who Stands To Benefit From QE2?

The markets have been all atwitter from the very first mention of the next round of quantitative easing via the Fed. As with any government (or in the case of the Fed, quasi-government) program, there will be winners, losers and unintended consequences. (For a closer look at QE, also check out Quantitative Easing: What's In A Name?)

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All told, the Fed expects to inject $600 billion into the system, primarily by having the Federal Reserve Bank of New York acquire Treasury securities from primary dealers like Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and Bank of America's (NYSE:BAC) Merrill Lynch. Although the precise details of the program may change as time goes on, the systematic purchases will likely have the most impact on the medium area of the yield curve.

The idea here is that the Fed says it wants to fight deflation and produce something on the order of 2% inflation. It is an open question as to where exactly the Fed is seeing deflation. True, housing prices are still dropping, but food prices are higher, gas prices are higher, electricity prices are flat-to-higher and so on. Nevertheless, a $600 billion program comes to almost 7% of the latest M2 money supply reading, so it will clearly have some impact on the economy and markets.

Banks Get Still More Help
For banks involved in a modified version of a carry trade, this is another boon. Large banks can still access capital at near-zero rates from the government (and near-zero deposit rates), turn around, and put that money into Treasury securities yielding about 2.8% today (on the 10-year). Though Fed purchases will theoretically push those rates down, the banks can then benefit from appreciation on the underlying bonds. Either way, there is no explicit requirement for banks to boost lending, and they can quietly repair their damaged balance sheets with this cheap money.

Cynics can have a field-day with this one because the banks benefit from this move in the short-run. Citigroup (NYSE:C) and the like are getting another chance to clean up their balance sheets, or perhaps this is just a way for the banks to tide themselves over during a period of tough business.

Commodity Companies See Higher Inflation
The prevailing sentiment is that the Fed is doing a "buy today, pay tomorrow" maneuver, with the "pay tomorrow" coming in the form of higher inflation expectations down the line. Even granting that the link between gold and inflation is imperfect (gold is more of a hedge against weak policy than pure inflation), the fact remains that inflation means higher prices for "stuff." If the price of "stuff" is going to go up, it makes sense that the providers and producers of "stuff" will see higher investor interest.

Whether it is copper companies like Freeport McMoRan (NYSE:FCX), gold companies like Newmont (NYSE:NEM) or even owners of timberland like Rayonier (NYSE:RYN), loose money usually means higher share prices for the "stuff" sector - to say nothing of SPDR Gold Shares (NYSE:GLD). Even energy companies can play along. A weaker dollar generally spells higher oil prices, and that seldom hurts investor sentiment for oil-heavy energy companies.

Debtors Can Gorge
For companies or individuals who can access credit, another round of monetary easing is going to lead to cheaper debt. Mortgage rates are still near multi-decade lows and even allowing that some of this is a product of low demand (notice the Toll Brothers (NYSE:TOL) and DR Horton (NYSE:DHI) are not doing great right now), lower benchmark rates will be good for borrowers. In the corporate world, this could be a development that saves major borrowers tens of millions of dollars in lower interest payments and/or gives them enough cheap capital that they can forgo issuing more expensive equity capital to fund future expansion.

The Bottom Line
Clearly there has been a great deal of reaction already to this Fed policy. Government and banking officials in Europe and Asia have decried the move, and fairly few economists, academics or foreign ministers have come to the defense. While other coincidental chaos around the globe, including trouble in Ireland and inflation-fighting in China, has muted some of the reaction and impact, it is hard to boost the money supply by 7% and not see some consequences.

While there are undoubtedly some industries and companies that will benefit in the near-term, nothing ever comes for free. Importers will have issues with a weaker dollar, and the U.S. consumer buys quite a lot of things that come from somewhere else. Moreover, consumers and producers will adjust their behavior towards higher inflation expectations down the line. In the near-term, though, it looks like financials are getting another round of help and the "stuff trade" is on once again. (For related reading, take a look at What Is Quantitative Easing?)

Find out what happened in financial news this week. Read Water Cooler Finance: GM's Dramatic Return.

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