Pundits have criticized this monetary policy. Here’s how your investments may be affected. [Wednesdays: The Independent Investor]
Miles Everson’s Business Builder Daily speaks to the heart of what great marketers, business leaders, and other professionals need to succeed in advertising, communications, managing their investments, career strategy, and more.
A Note from Miles Everson:
We’re excited to share with you another investing insight in today’s “The Independent Investor.”
Every Wednesday, we publish articles about investing because we want to help you achieve true financial freedom.
Today, we’ll be discussing how this specific monetary policy impacts both the economy and stock market.
Continue reading to know more about this topic.
CEO, MBO Partners
Chairman of the Advisory Board, The I Institute
The Independent Investor
For the past few years, the U.S. Federal Reserve, a.k.a. the Fed, has attempted to stabilize the economy through its fiscal policies. In particular, it put into effect quantitative easing (QE) in March 2020 to stimulate economic activity in the wake of the COVID-19 pandemic.
However, this decision has received criticism from some pundits. According to these observers, the monetary policy caused the inflationary problems the U.S. is facing today.
To understand the issue further and to explain how this impacts your investments, we need to know what quantitative easing exactly is first…
Photo from Advisor’s Edge
QE is a form of monetary policy that enables central banks like the Fed to stimulate economic activity during a financial crisis.
By purchasing financial assets like government and corporate bonds, stocks, and other types of assets.
Through this fiscal tool, the amount of money circulating in the economy is increased, thus lowering interest rates and the cost of borrowing. When this happens, banks have more cash to lend, incentivizing both individuals and businesses to borrow and spend more.
Simply said, this fiscal tool is the “grease” that turns the wheels of the economy during a crisis.
So, does QE actually work?
According to some experts, the monetary policy helped stimulate U.S. economic activity in the aftermath of the Great Recession in 2008 since QE encouraged borrowing and spending. Despite this positive opinion, observers are still divided about QE’s impact on the country’s economy.
They believe that while QE can stimulate economic activity, it can also cause inflation if a central bank puts too much money into circulation.
Additionally, even though QE increases liquidity for banks, these institutions can choose not to scale their lending activities. When this happens, cash is simply held at banks while firms hoard money to protect themselves from an uncertain business environment.
The fiscal tool may also devalue the domestic currency as the supply of money increases. Once this happens, imports become more expensive, leading to an uptick in the cost of production and consumer prices.
Despite these risks, the Fed hasn’t stopped itself from using QE after implementing it for the first time in 2009.
Since then, the fiscal tool was used in 2010, 2012, and most recently, March 2020. That time, the U.S. economy took a huge beating due to the negative effects of the COVID-19 pandemic.
Now that we have a clear picture of how QE works, it’s time to discuss how it can impact the stock market.
According to some financial experts, QE can boost U.S. stock market gains. However, there are other effects as well.
For starters, since the fiscal tool pushes interest rates down, the returns for safe investments like money market accounts, certificates of deposit (CDs), Treasuries, and corporate bonds go down. As a result, some investors might consider riskier investments to boost the performance of their respective portfolios.
Additionally, falling interest rates encourage companies to expand their businesses since the cost of borrowing goes down. When this happens, investors are more likely to buy stock, causing prices to rise.
According to some analysts and experts, the Fed can alter price signals in the stock market through QE. Under normal conditions, stock prices are determined through investor preferences, demand, and business conditions.
By lowering interest rates, the fiscal tool encourages speculative activity in the stock market, leading to prices that no longer accurately reflect a company’s valuation and investor demand.
So, as an investor, what can you do to protect your portfolio?
Here are a few tips:
- Study the credit of the companies you plan to invest in. Analyzing this specific aspect of a firm’s operations will enable you to determine whether it’s worth investing in or not in any type of market situation.
- Take a look at the financial statements and performance of the firms you plan to invest in. Balance sheets are a good indicator of a firm’s profitability.
- Avoid making trades based on your emotions or market sentiments. Fiscal tools like QE can send markets and its observers into euphoria because of its positive effects.
Take note of these tips to protect your investment portfolio!
As we’ve discussed above, the stock market can be impacted in multiple ways by a fiscal tool that’s supposed to stimulate economic activity. While this can be worrying for some, there’s no need for you to panic especially if you know how to protect your portfolio.
Stay tuned for the next “The Independent Investor!”
Happy mid-week, everyone!
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
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“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
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Hope you’ve found this week’s insights interesting and helpful.
Stay tuned for next Wednesday’s “The Independent Investor!”
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