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"Let them eat spooz" may best describe the strategy of U.S. monetary policy.
For those unfamiliar with trader jargon, "spooz" are S&Ps, as in the Standard & Poor's 500 futures contracts that are the preferred instrument that hedge funds and other speculators use to express their bullishness or bearishness on the U.S. equities market.
As described in an op-ed article in the Washington Post published right after the launch of QE2 last November, Federal Reserve Chairman Ben Bernanke explained that the purchase of $600 billion of Treasury securities was explicitly intended to inflate asset prices. "Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion," he wrote.
Indeed, since Bernanke floated the idea of additional purchases of Treasuries last August, the value of the U.S. stock market has ballooned by 25%, or $3.2 trillion, according to Wilshire Associates. Those gains have accrued to those sufficiently well-off to own financial assets, such as stocks.
But the rise in U.S. stock prices is far less impressive when seen from abroad. Viewed from the perspective of a European, the 25% increase in the dollar value of U.S. equities is offset by a nearly 10% fall in the dollar against the euro since late August.
The loss of the purchasing power of the dollar is apparent at home as well. Those who have to pay nearly $4 for a gallon of gasoline or a loaf of bread as a result of the rise of commodity prices that followed the Fed's talk of additional Treasury purchases wish they were long S&Ps in order to gain some of the benefit of the Fed's liquidity expansion.
Also on the short end of the stick are those savers who stashed their dough in what they thought were safe and secure municipal-bond funds. Instead, they lost out on two fronts. Treasury bond yields jumped, from a low of 2.5% for the benchmark 10-year note to around 3.3%, resulting in price declines rippling through most of the U.S. credit markets.
Then they were spooked by "the sky is falling" predictions of massive defaults on municipal bonds, which has resulted in about $27 billion being yanked from tax-exempt bond funds since last November.
As a result of this panic, individual investors have fled what is one of the most attractive sectors of the bond market. In their place, the big money from hedge funds have been swooping in to take advantage of the values that continue to be available in the muni market
That's been, in part, a result of the fears of "hundreds of billions of dollars' worth of defaults" predicted by analyst Meredith Whitney on CBS's 60 Minutes late last year. The basis of that forecast remains shrouded from public view amid charges of sexism against Whitney's critics, who point to the lack of substantiation for her predictions of municipal defaults, which are vastly in excess of those seen at any time in history, including the Great Depression of the 1930s.
In fact, the municipal credit cycle is improving, observes Jeffrey Schoenfeld, head of fixed-income for the venerable private bank of Brown Brothers Harriman. The recovering economy is benefitting tax revenues while financial market vigilantes are forcing state governments "to do the right thing" to rein in soaring budget deficits.
Despite these positive trends, individual investor have suffered losses from the fall in muni-bond prices. The iShares S&P National AMT-Free Municipal Bond exchange-traded fund (ticker: MUB) is down 7% since late August, even after a 3% bounce since January.
Investors who dumped muni funds sold out at depressed prices and may have taken losses. Meanwhile, large institutions now are snapping up attractively priced long muni bonds. Top-grade 30-year munis continue to out-yield comparable Treasuries by 30 basis points, 4.73% to 4.43%. Opportunistic buyers such as pension funds -- which don't benefit from the tax-exempt interest from muni bonds since they don't pay taxes -- are crossing over into munis to take advantage of the yield anomaly in the expectation it will correct by municipal bond prices rallying.
It seems risk-averse individual investors have come out on the losing end of recent trends. Unless they were willing to buy stocks, they haven't benefitted from the Fed's policies. Because they persist in eating and driving, they don't benefit from low "core" inflation that excludes those non-essentials of food and energy. And if they sought tax-free income, they were whipsawed by panic precipitated by sensational but unsupported dire predictions of municipal defaults.
Ultimately, it's their fault for not being long the S&P 500, so they shouldn't complain.
Comments? E-mail: randall.forsyth@barrons.com
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