QE3 Ushers in a New Breed of Income

10/03/2012 10:37 am EST

Focus: STRATEGIES

Jim Trippon

Editor-in-Chief, China Stock Digest

In the latest era of cheap money, income investors are looking in new places to find solid total returns, writes Jim Trippon of Dividend Genius.

On Thursday, September 13, the Fed announced its plan to stimulate the economy with a commitment to buy $40 billion of agency mortgage debt per month with an open–ended time frame. The Fed’s plan would continue the bond–buying program until the unemployment rate significantly drops from the current 8.1%.

In a related move, the Fed announced it was likely it would keep its near–zero interest rates until mid–2015, which extends its previous target date of 2014. The monetary policy moves were intended to stimulate what is still a slow–growing economy to produce a more robust recovery.

The stock market immediately reacted positively. Volume for equities hit nearly a three–month high, as more than 8 billion shares traded on the day, with many stocks reaching new highs. The S&P 500 surged 1.63% to 1,459.99. The Dow rose 206.51 points to 13,539.86.

The most economically sensitive sectors, financial, energy, and material stocks, jumped the most. The beaten–down sector of basic commodity stocks, such as coal, iron ore, and steelmakers, was one area that lifted off, while bank stocks reacted well to the news. Oil stocks such as ExxonMobil (XOM) rose nearly 2% immediately.

Critics Decry
While the stimulus was expected, many analysts feel it won’t produce the desired remedy. The mortgage bond buying may not bring much more than a temporary boost to the wounded housing industry, as housing’s problems may be far deeper than low interest rates can solve.

The point has been made that we already have low interest rates, and that the key to credit availability is for mortgage lenders to do more lending. There’s no way to compel or guarantee that to happen. There is also a serious question whether the flow of more Fed money into the economy is going to produce the kind of economic growth it seeks.

Hiring remains slow, as companies need to see better clarity on potential results for their investment in personnel, facilities, and research. There is also the somewhat arcane question of the possibility of a liquidity trap, a Keynesian term which describes the phenomenon that when interest rates are so low, savers take even more money out of circulation.

This is part of a “low money velocity” economy that doesn’t circulate sufficient money, causing a further slowdown of economic activity—the opposite effect from what the Fed intends. That said, the effect of priming the economy’s pump with more liquidity should boost the stock market for at least the short term. The classic effect of more money available in the system and is part of what can make equity values rise.

The addition of more money into the economy, along with the damping down of interest rates–many would say artificially–for the next couple of years, makes dividend stocks even more attractive. Income investors are finding fewer and fewer attractive alternatives for their money, and the Fed’s move has all but discouraged bond investing.

Income stocks, or better yet growth and income or high–yielding stocks, instead have the potential reward for income investors who at the same time can balance their portfolios with growth stocks or other equity investments that now look more appealing. One stock that may become the paradigm for the new, classic growth and income stock may be Apple (AAPL).

Even so, this market under the Fed largesse will not be an either–or market—that is, either growth or income. Dividend stocks will continue to flourish along with any growth, due to the lack of income alternatives and the floor the Fed is trying to install on this economy.

It’s been a good time to be a dividend investor. It should remain so.

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