Investors are funny -- we hear that Quantitative Easing has ended and assume that without any "training wheels," the U.S. economy will fall down and scrape its knees on the sidewalk. How easily we forget that the economy seemed to get along just fine prior to the 2005-07 housing-and-credit boom and subsequent 2008-09 housing-and-credit bust.
Now, it's very possible that our economy and world might look drastically different today had the Federal Reserve not taken bold, crisis-time actions. But when your car battery dies, do you abandon it on the side of the road and buy a new one, or do you simply replace the battery because the rest of the vehicle remains functional?
What Is QE, Anyway?
At this point, most everyone knows that Quantitative Easing was a form of fiscal stimulus in which the Fed injected trillions of dollars into the system by buying up Treasury bonds and mortgage-backed securities between late 2008 and 2014.
This exercise pushed interest rates to their lowest levels on record, which was meant to spur investment and spending. The Fed's experiment with QE (which it hadn't tried before) clearly worked, although questions remain as to what extent it succeeded and whether there have been unintended, negative consequences.
But since QE bond purchases officially ended in October 2014, the U.S. economy has been operating without stimulus more more than a year, right? Wrong!
QE's Positive Effects Are Far from Over
QE's true purpose wasn't about the Fed owning $4.5 trillion worth of bonds, but about pushing interest rates down to encourage spending and investment (and discourage saving).
Well, interest rates are still lower today than when QE began, and investors who chose for one reason or another not to abandon overweight bond allocations haven't really been punished so far:
What to Buy When Bonds Finally Tank
Of course, the bond-price rally over the past six years has masked a declining rate of interest earned on fresh money put to work in fixed income. The fact that high-quality paper only pays a miniscule 3% coupon isn't as painful as long as bonds are worth more than I paid for them a year or two earlier.
But what happens when a bond is no longer worth more than I paid for it a year or two ago? We have yet to see more than a quarter or two since QE began where a portfolio of low-risk, fixed-income investments actually lost value -- but we eventually will.
Given the insultingly low coupons on bonds that haven't been called yet, interest rates don't have to move much higher to create total return losses. And when that happens, I think we might finally see some capitulation among bond investors.
Where should they go to improve their cash flow? My advice: U.S. large-cap value stocks.
An improvement in fund flows -- coupled with a little break in the U.S. dollar's strength -- could spark a resumption in the uptrend for large-cap, dividend-paying stocks. And as this chart shows, a break in the dollar might already have begun:
Large-Cap Value ETFs Beat the Long Bond
The iShares Select Dividend ETF (DVY) currently yields 3.27%, which beats the 30-year U.S. Treasury's sub-3% return.
DVY's top holdings include blue chips Lockheed Martin (LMT), Philip Morris (PM), Kimberly-Clark (KMB), McDonald's (MCD), and Chevron (CVX), but there are many ways to skin the large-cap value cat.
For instance, the Energy Select Sector SPDR ETF (XLE) is currently yielding around 3.29%, although that fund will likely remain volatile over the short term (for obvious reasons).
Another option: The iShares Russell 1000 Large Cap Value ETF (IWD), whose 2.36% current yield beats the 10-year U.S. Treasury.