What Central Bank Money Printing Means for Small-Cap Stocks | ASXnewbie.com

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What Central Bank Money Printing Means for Small-Cap Stocks.

by strudy1

By now you probably know that the US Federal Reserve has launched a new money printing program. The media refers to it as QE3.

The ‘QE’ refers to the term quantitative easing, and means that the Fed will increase the quantity of money in the economy. And the ’3? refers to this being the third time the Fed has launched such a policy.

The Fed’s plan is to buy USD$40 billion-worth of mortgage-backed securities each month. The idea is that as institutions sell these mortgages to the Fed they’ll use the proceeds as capital to secure more mortgages, this will increase the odds of banks’ lending money to home-buyers, which should make it easier to buy a house, which will boost house prices…

…and cause another housing bubble.

The Fed’s Plan Won’t Work
OK. The Fed wouldn’t dare admit to the last bit. But that’s really the name of the game. Most in the mainstream still believe house price growth is positive for the economy, and that if it wasn’t for the subsequent price collapse everything would have been fine.

Their aim now is to build another price bubble, but this time try to make sure it doesn’t collapse.

Whether the plan works or not is another question. I don’t think it will…or not in the way the Fed intends anyway. Even if they succeed in causing another bubble, the outcome will be exactly the same…if not worse.

But aside from that there’s the issue of money printing and the impact on stock markets. In each of the other two rounds of money printing, the plan has only partially worked.

Interest rates have fallen close to zero, yet the official unemployment rate remains above 8%. And some unofficial statistics say the unemployment rate is really closer to 20%.

Clearly the policy has failed. But that hasn’t stopped them trying it again.

The fact is what the US and world economy needs is less printed money, not more of it. It’s the constant injection of newly printed money that causes economic distortions, and the boom and bust cycle.

But complaining about it is easy, and the Fed won’t listen to my opinion anyway. So, if there’s nothing you or I can do to stop the money printing madness, is there anything you can do to profit from it?

How to Play the Stock Market Over the Next Two Years
Each round of money printing has had less of an effect than the previous one. Most of the time the excitement and stock market rally has actually happened before the official money printing announcement.

So that by the time the Fed tells the market what’s happening, investors have already priced in the good news.

That could mean the best stock market gains based on the current round of money printing have already happened. And because QE3 is a continuous program, you won’t get the kind of broad market boost even as the Fed continues to print money.

That should tell you something important. Whether it’s small-cap or blue-chip stocks, the last thing you’ll want to own over the next two years is a broad basket of stocks.

The best approach is to own shares of businesses that you believe have the best chance of out-doing the rest of the market over the next two years.

If you’re looking at blue-chips, then good dividend payers or beaten down recovery stocks makes sense. And in the case of small-caps the strategy is to buy stocks that have the best chance of doing something extraordinary…

  • Energy stocks searching for oil and gas fields.
  • Technology companies looking to exploit a new or niche market
  • Resource stocks exploring for a new resource, or about to produce from an existing resource

There are many other scenarios, but I think you get the picture. When the whole market goes up, you can buy almost any stock and make a killing. But when the broad market stagnates (as I expect it to), that’s when it makes sense to punt on and invest in individual stocks…especially the stocks with an interesting story to tell.

Kris Sayce.
Editor, Australian Small-Cap Investigator.

This article is contributed by Money Morning. Click Here to Subscribe to their free newsletter.