Quantitative Easing (QE) 2

This week’s blog is about the US Fed’s (Federal Reserve) announced policy of quantitative easing 2. On November 3 the Fed announced that it intends to buy an additional $600 billion of longer-term treasury securities by mid 2011, which equates to about $70 billion per month. The Fed will continue to review the size of its overall securities purchases and the overall size of the program; after reviewing incoming data, they will adjust the program as needed to increase employment and keep prices stable.

Why is the Fed doing Quantitative Easing 2? The US continues to experience persistently high unemployment. Job growth of between 150,000 and 200,000 per month is required just to absorb the new employees entering the job market. The current GDP growth rate is around 2% and the inflation rate is less than 2%. Over the last 2 years the Fed and the US government have tried a number of programs in their attempts to jump start the economy and increase employment.

Examples of programs the US government and the Fed have tried over the last 2 years:

Fed fund interest rate: The Fed has decreased the fed fund interest rate to a historic low of .25% (it was 4.75% in 2007). It can only go down to 0%. At this level the Fed cannot use this to kick start the economy and increase employment. Home mortgages are at a record low.

Large federal government stimulus: In 2009 Congress passed and President Obama approved a $787 billion stimulus package to help stimulate the overall economy and employment growth. With the enormity of the budget deficit and the Republican Party taking over the House of Representatives there is little or no political will for a new federal government stimulus in 2011.

QE 1 (2009): The Fed started quantitative easing 1 back in March 2009 when it began a program of outright purchases of treasury coupons, GSE debt and mortgage-backed securities. QE1 lasted about 1 year and the Fed increased the money supply by about $600 billion.

This was not the first time the US government used cutting fed fund interest rates and large stimulus programs to stimulate the economy. For the first time in US history it has not been successful. Without the ability to lower the fed fund rate (it could go to 0%) and without Congress having the will to approve a new large stimulus program the Fed thinks the only arrow left in the economic stimulus policy quiver is to carry out QE 2 to help the economy grow and increase employment.

What is Quantitative Easing (QE) 2? In very simple terms, it is injecting (printing) money directly into the economy. This is supposed to lower interest rates and increase the money available for lending. How are the Feds doing this? The Fed will distribute new money at a rate of $70 billion per month and go to financial institutions to buy $70 billion of government bonds at a higher rate than others will pay for them. In a perfect world the financial institutions will then lend out money to companies or people who will in turn invest or spend it. This should pave the way toward overall economic growth.

Issues and problem with QE 2: The major problem with quantitative easing is that it will devalue the US currency. This has the positive effect of making US exports cheaper (it is a positive for companies that export and should help their stock price) for companies or consumers outside the US. It will have the opposite effect with imports which will become more expensive for US companies or consumers to buy. This can lead to currencies wars with countries that export to the US since their products will be more expensive which would tend to decrease demand for them. They may need to devalue their currencies to be able to sell in the US. Since most commodities are valued in $ US it will drive up the cost of commodities. This may have a negative effect on poor people around world since they spend a greater percentage of their money on commodities such as food, fuel, etc.

The positive effect of QE 2 is that interest rates may decrease which will in theory help to grow the economy. This will assist consumers or companies that need loans, for example to refinance their homes (and have more money to buy goods), buy homes, cars, etc. and for companies to purchase new equipment. This has a positive affect for people that need to borrow money and negative effect for people or companies that save money (they will receive lower interest yields and their dollars will be devalued).

Is it working? It is still early to determine if QE 2 is working. Since it was put into effect on November 2 all the Fed treasury bills, notes and bonds yields have increased (as of November 19th). For example, 7 year and 10 year treasury notes have increased 33 basis points (a basis point is .01%) and 30 year bonds have increased 32 basis points. The reason for this might be that investors perceive quantitative easing 2 will feed inflation in the future. Success may also be subverted if financial institutions will only lend money to consumers with high credit worthiness (unlike pre financial crisis when almost anybody could get a mortgage).

Please chime in with comments about QE 2. Do you think it will help the economy, will it lead to currencies wars and stagflation, increase commodity prices, etc. Future blogs that I will be writing:

Income generating bucket of money

Investing in possible buyout companies

Investing in Brazil

Using Fisher’s Common Stocks and Uncommon Profits and Other Writings15 points for researching companies to evaluate one company

Best investments for Quantitative Easing (QE) 2

Paul

© 2010 Paul Cusick

Common Stocks and Uncommon Profits by Philip A. Fisher

This week’s blog is a review of the classic investment book written for both the nonprofessional and professional investor, Common Stocks and Uncommon Profits by Philip A. Fisher (Investor Ken Fisher’s father). This classic financial / investment book was written in the 1950s. Common Stocks and Uncommon Profits had a great influence on Warren Buffet’s investment philosophy (as did the investment books penned by Benjamin Graham). This is a book that should not be read just once; it should be read over and over until you have a complete understanding of its content. It is the ‘bible’ of growth stock investing – sill utterly relevant 50 years after it was written.

Mr. Fisher’s strategy was simple; invest in a small portfolio of companies (around 15) which will continue to grow revenue and profit over the years. Using his investment methods if a company is correctly selected you may never have to sell the company and at the same time will make large gains over time (i.e. 5 to 10 times return on investment). He is the father of growth stock investing. Mr. Fisher was always looking for superlative companies that he could buy and hold for an extended period.

Mr. Fisher developed a list of 15 points to research before buying a stock to help him select superlative companies. This list is still valid 5 decades after he wrote it. Some of the points, however, do need to be modernized. Examples of the 15 points:

• Point 1: Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

• Point 2: Does the management have a determination to continue to develop products or processes that will further increase total sales potential after the growth potentials of currently attractive products lines have largely been exploited?

• Point 4: Does the company have an above-average sales organization?

• Point 6: What is the company doing to maintain or improve profit margins?

• Point 14: Does the company have a management of unquestionable integrity?


Examples of the points would need to be adapted for the present time:

• Point 4: Does the company have an above-average sales organization? Today a large number of companies no longer have salespeople (if they do it is still valid point), I would expand the research to determine if the company has positive (high) brand recognition, customer satisfaction, page ranking of the company website, etc. There are many surveys on the best global brands in the world and customer satisfaction (for example the customer Net Promoter Score). You can you use Google’s page rank checker tool to check the page rank of a company’s website.

• Point 7: Does the company have outstanding labor and personnel relations? Mr. Fisher talks about developing good relations with a company’s labor unions. Most private companies in the US and around the world no longer have unions. I would review surveys of ‘best companies to work at’ (Fortune magazine does a very good survey every year of US companies). By googling ‘best companies to work at’ I quickly found surveys for Brazil, England, India and other countries.

Mr. Fisher also gives 10 more don’ts for investors. For example, don’t assume high price is an indication of future growth, don’t buy stocks because you like the tone of the annual report, don’t overstress diversification, don’t be afraid of buying during a war scare (or any scare), etc.

The scuttlebutt method is one Mr. Fisher used for researching companies. He did not rely on Wall Street research or newspaper or magazine stories for his research. If he was living today he would not be watching CNBC or Fox Business for his information, only for entertainment. With the scuttlebutt method you talk with people that can give you information about a company. For example, you talk with the companies that compete with the company that you are researching. You would find out what company they believe will be their most important competitor currently, in the future, etc. Another example: you would go talk with their customers to determine what the customer thinks about the company. You would go talk with the industry experts, suppliers, the company management, employees that left the company, people in the academic field, etc. Mr. Fisher did not spend much time looking at financial reports on any company in which he was interested.

If he were alive today, Mr. Fisher would be partial to companies that continue to develop new products which would contribute to the growth of sales revenue. He would break down revenue by the year the contributing product was introduced to the marketplace. This would show that the company had outstanding research and technical effort and they can work well with the marketing, production and sales organizations to develop products that customers want. Mr. Fisher also liked companies to have organic growth (growth within) and would limit how many companies he bought.

I would include Philip A. Fisher’s Common Stocks and Uncommon Profits in any financial library. It is the classic reference book on growth stock investing. If you own only two investing books buy Common Stocks and Uncommon Profits and Security Analysis: the 1936 or 1940 edition by Benjamin Graham and David Dodd. Security Analysis is the classic reference book on value investing.

Please chime in with comments about Common Stock and Uncommon Profits. Would you use Mr. Fisher’s 15 points for buying / selling stocks in today’s financial environment? In a future blog I will utilize Mr. Fisher’s 15 point method to evaluate 1 or 2 companies. Future blogs that I will be writing:

Income generating bucket of money

Investing in possible buyout companies

Investing in Brazil

Using Fisher’s 15 points researching companies to evaluate one company

Best investments for Qualitative Easing (QE) 2

© 2010 Paul Cusick

Investing in Brazil

In this week’s blog I will investigate whether Brazil is a good investment opportunity that would serve to diversify my investment portfolio with an emerging economy / country, and add growth potential to my overall portfolio. This week I will focus on a summary of the Brazilian economy and review investment vehicles. In a following blog I will focus on investing vehicles and opportunities.

One of the four BRIC (Brazil, Russia, India and China) countries, Brazil will have the seventh largest economy by Gross Domestic Product (GDP) by the end of 2010. Their GDP will be over $2 trillion US in 2010. Projecting 3 to 5 years out, they may become the fifth biggest economy by GDP, overtaking France and the United Kingdom.

The following are reasons why Brazil will be one of the leading economies of the 21st century:

Some segments of Brazil’s economic growth have been stunning:

· Since the 1970s Brazil has transformed itself from a food importer to one of the biggest food exporters in the world. In a ten year period from 1996 to 2006 they increased the total value of their crops from $23 billion to $108 billion. Brazil has more farmland (only 25% is in use) and renewable fresh water than any other country in the world. They are the biggest exporter in the world of the following agricultural commodities: Orange juice, sugar, chicken, beef and coffee and second for maize and soybeans. Given the ever growing world population and the increasing economic power of China and India, the two largest countries by population, Brazil will have a continuously expanding marketplace for their food products.

· In 2007 Brazil Petrobras (the government controls 40% of the stock with 50% of the voting stock) discovered potentially the fourth biggest oil field in the world estimated to hold over 40 billion barrels of oil. In the last 3 years they have discovered sources thought to potentially contain over 50 billion barrels of oil. Petrobras has announced the world’s largest capital-expenditure program – worth $175 billion US – over the next 3 years. To help with the cost-expenditure program they had the biggest stock offering ever in September 2010 raising $70 billion US. In the future Brazil will become the fifth largest oil producing country in the world.

· Brazil was selected to host the 2014 soccer World Cup and 2016 Summer Olympics. These events will require Brazil to make large infrastructure improvements including new roads, mass transit, housing, etc. that will contribute to improving the overall economy in the future.

Other interesting economic facts about Brazil:

· Brazil is the second largest (the US is first) bio-ethanol producer (using sugar or starch based material) and largest exporter to other markets.

· Fourth largest road network in the world (by miles)

· Second largest iron producer in the world

· Ninth largest steel producer in the world

· Sixth largest motor vehicle producer in the world

· Brazil Embrarer is the third largest maker of passenger jets and the biggest producer of mid-range passenger jets in the world.

· In 2008 and 2009 it was the world’s fastest growing marketplace for cars.

In some ways Brazil is still an emerging economy. It has unwieldy labor and tax laws (which have led to a very large informal economy). It can take years to fire an employee. In a recent World Bank survey on conducting business, Brazil ranked 150th out of 183 countries on how easy it was to pay taxes. Business contract disputes can be almost impossible to resolve as there can be virtually endless appeals of any court decision. Brazil may have the fourth largest road network in the world but only 12% of it is paved. This makes it difficult, time consuming and costly to move goods within the county and export. Brazil had the ninth highest murder rate in world in 2009 (although it has been decreasing over the last 5 years).

When you invest in Brazil you are looking for a return on investment and at the same time hedging against your own country’s currency (unless you are from Brazil). For example, if a Brazilian bond fund yields 5% in 2011 and the Brazilian Real gains 10% against the US dollar in 2011, your total return will be 15%. With the US Treasury Department entering into a 2nd period of quantitative easing (QE2) starting the week of November 1, 2010, it will drive the Brazil Real higher versus the US dollar over the next year (and other currencies). At the same time it will increase the price of Brazil’s exports (and other countries’) which would in turn reduce their ability to export products.

Some possible investing vehicles for Brazil:

· BRIC ETFs

· Regional ETFs (i.e. Latin America)

· Brazil ETFs

· Individual stocks (i.e. the 5 largest companies in Brazil)

· Brazil government bond funds

· Brazil bond funds

· Brazil Certificates of Deposits (CDs)

Disclosure: I have the following investments in Brazil:

· DWS Latin America Equity Fund (SLAFX) - 67% of the portfolio composition is invested in Brazil

· Guggenheim ETF (EEB) - 55% of the portfolio composition is invested in Brazil

· SPDR S&P BRIC 40 (BIK) - 25% of the portfolio composition is invested in Brazil

Please chime in with comments about the economic future of Brazil. Should I increase my investments in Brazil? What are the best investments to make in Brazil? What are your favorite financial and investment books, ideas for future blogs, etc.? Future blogs that I will be writing:

· Income generating bucket of money

· Investing in possible buyout companies

· What Investments to make in Brazil

· Reviewing the classic financial book (written in the 1950’s): Common Stock and Uncommon Profit by Philip A. Fisher

· Using Philip A. Fisher’s stock picking methods to analyze stocks

© 2010 Paul Cusick