The odds of another round of stimulus from the Federal Reserve appear to be a possibility in the minds of most investors. I believe the chance of quantitative easing three (QE3) is very high and that investors must be positioned for today. The timing of the next round of QE is anyone's guess. However, I do feel it could occur before the end of the summer and that it will result in a rally in the stock market and other specific asset classes.
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An announcement of QE3 would result in a calming effect on investors and therefore, the risk-on trade would be back in full force. When investors are comfortable taking risk, the high beta stocks typically outperform. This is why the PowerShares S&P 500 High Beta ETF (ARCA:SPHB) should be a big winner.
The ETF is composed of 100 stocks in the S&P 500 with the highest beta and most sensitive to market movements. Currently, the ETF is made up of roughly 37% financials, 21% energy and 13% information technology. The financials tend to move on every piece of news from Europe. Therefore, it is not surprising to see the sector at the top of the list. Large financial firm, Bank of America (NYSE:BAC) is the largest holding, with over 1.3% allocation. The ETF charges a 0.25% expense ratio and has a SEC 30-day yield of nearly 1.2%. Year-to-date, the ETF is flat and lagging the S&P 500.
Dollar and Gold
More easing will weigh on the U.S. Dollar, because it will add liquidity to the market and lower the value of the currency already in circulation. At the same time, a weak greenback is historically positive for the price of gold and other commodities.
To play a drop in the U.S. Dollar, there is the PowerShares DB U.S. Dollar Bearish ETF (ARCA:UDN). The ETF moves in the inverse of the U.S. Dollar Index, which is an index that bases the greenback against a basket of foreign currencies. Therefore, a drop in the value of the U.S. Dollar versus foreign currencies will result in a drop in the index and the ETF will gain in value. Year-to-date, the ETF is down about 0.6%, as the U.S. Dollar has been holding up well as a safety investment.
After a decade of large gains, gold has struggled in 2012, as large owners of the metal have been forced to liquidate. The good news for gold bugs is that recently, the metal has found support and is back near a two-month high. The SDPR Gold ETF (ARCA:GLD) is up 6% from the May low, after finding support at the crucial $148 level. There's also the fact that investors will be looking for a currency alternative as the greenback falls and most other major currencies deal with issues of their own. This leaves gold as the likely option.
SEE: 8 Reasons To Own Gold
Lastly, a niche area in the bond market could also be a winner with another round of QE. The SPDR High Yield Bond ETF (NYSE:JNK) is composed of a basket of several hundred high-yield corporate bonds and it currently yields 7.4%. A result of easing will be the Fed artificially keeping interest rates low on U.S. bonds. In order to achieve high yields, investors must turn to alternative options. Junk bonds offer the high yields and are tied closely to the performance of stocks. A win-win in the event QE3 happens.
The Bottom Line
There is a risk that QE3 does not occur. I only see that scenario if the economy fixes itself and the fears in Europe subside quickly. If that is the case, it will be good for stocks and SPHB, but it will be bad for the U.S. Dollar (UDN) as money goes into the euro, good for gold and GLD, and JNK will move higher, with money flowing into riskier assets tied to stocks. As a result, it looks like there is a better-than-average chance that the aforementioned ETFs will do well.
At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.