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Fed Puts Stamp of Approval on Riskier Assets

ByEddy Elfenbein, Contributor to TheStreet

NEW YORK (TheStreet) -- The Federal Reserve is expected by investors and economists to announce a second round of bond purchases, or so-called quantitative easing (QE2). Investors need to understand that QE2 will have a major influence on their investments. The most important aspect is that quantitative easing will help fuel a demand for riskier assets. More specifically, quantitative easing will aid a shift toward growth stocks at the expense of bonds and value stocks. QE2 won't affect the direction of the stock market, though that will remain strong, as much as it will alter the market's internal leadership. Now let me back up and explain this in detail. Over the past several weeks, the Federal Reserve has made its QE intentions clear. I'm surprised the group hasn't taken out a full-page ad in the Wall Street Journal. The Fed's main problem is that the economy is still grinding its wheels, as Friday's GDP report shows, and interest rates are already at 0%. As a result, the central bank now plans to inject money into the economy by buying enormous amounts of U.S. Treasuries. The only question now is how much? The general consensus on the Street is that QE2 will clock in around $500 billion, although some say it could be as much as $1 trillion. We're really in unchartered territory here. The plan will be less than the Street expects. Remember, the C in FOMC is for "committee" and that means comprises. We can expect uber-hawk Thomas Hoenig, the president of the Kansas City Fed, to be a "nay" vote, and he may be joined by one or two others. I expect an announcement of around $250 billion, give or take, which may even cause a near-term pullback. Much like a pampered Hollywood starlet, Wall Street just loves to be disappointed when it receives favors. So where will Bernanke and his buddies get all this cash? That's easy. They have a magical power in which they can write checks out of thin air. Or at least, they can create currency out of thin air. The U.S. dollar has already gotten smacked around in the currency pits lately, although it's not nearly as bad as the dollar haters make it sound. My thesis that the Fed's purchasing of debt will lead an exodus out of Treasuries and into riskier assets may sound counterintuitive. The important point is the market is already heavily tilted toward low-risk assets. Currently, there's a lot of money -- too much money -- sitting on the sidelines. Moody's Investors Service reports that U.S. companies are sitting on $943 billion in cash. Three companies -- Cisco , Microsoft and Google account for the largest portion. Hey, who needs the Fed? They could do a QE all by themselves! The simple fact is, to paraphrase Jimmy McMillan, bonds are too damn high. In fact, the move out of bonds has already started. Last week, the yield on the 30-year Treasury closed at its highest level in nearly three months and it's now over 50 basis points from its low point in late August. Not by coincidence, that was right when the stock market bottomed. In short, the stock rally has been at the expense of bonds. What this means is that, at long last, investors are finally choosing sanity over liquidity. Let's look at some numbers: Since Aug. 31, the S&P 500 is up 13%. That's a nice run but the growth side of the index as measured by the S&P 500 Growth Stock Index, is up 19%. That's nearly double the 10% gain for the S&P Value Index. Here's the key to understanding QE2's impact: Don't think of it as a stock movement. Instead, think of it as a risk movement with a seal of approval from the Federal Reserve. Disclosure: The writer owns none of the stocks mentioned. You can see his complete buy list and sign up for his free e-letter.

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