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Farr: Are You an Investor or a Trader?

QE2: And we're not talking about the ship or the Queen

Fed Governor Jim Bullard was the guest host on Squawk Box Friday. He sounded somewhat more temperate in his support of additional quatitative easing but was quite eloquent in not overly committing himself. (You can watch the interview here) The unemplyment number realeased at 8:30was not good, and greater pressure to ease is upon the Fed.

Ed Yardeni and others have been quick to criticize the ultimate ineffectiveness of quantitative easing. Ed points out that the “multiplier theory” has never been demonstrated outside of undergraduate classrooms. But if it were indeed completely ineffective, why aren’t they able to unwind what has been done? If the Fed’s portfolio really doesn’t do that much, then why can’t they quickly sell the massive portfolio of Treasuries and mortgage-backed securities now that the credit markets have improved?

Quantitative Easing (*CNBC 101: 'Quantitative Easing': What Does It Really Mean for Investors?) was a part of what saved our economy and banking system from collapse.

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It’s effectiveness in stabilizing the credit markets should not be questioned.

However, it is now being criticized for not creating jobs. Job creation would have been a nice outcome, but a far more necessary result was realized.

If QE helped to save the economy from financial collapse, what qualifies it as the proper approach for stimulus?

If stimulus is indeed needed, why employ QE? It’s scary that all problems begin looking like nails when your only tool happens to be a hammer.

Please see last week's market note in which we suggested that "bad news is good news again." The stock market rallied on the bad emplyment news because of the increased certainty that the Fed will act, and government money will bouy share prices.

It's Always the Economy Stupid

Unemployment is the big problem, and it’s not likely to get better anytime soon. Dr. Nancy Wentzler is Deputy Comptroller of the Currency and Chief Economist and a GREAT friend. Nancy is concerned about the structural changes on the employment landscape rather than the cyclical challenges. She points out that the new check-in kiosks at airlines and check-out kiosks at grocery stores and other retailers like Home Depot have permanently replaced a lot of clerks. Auto manufacturers and auto sales people have lost jobs that are unlikely to return. The same is true in financial services. A loss of 8 million jobs is devastating especially when our country’s growing demographics mandate creation of 1 million jobs a year just to maintain the current unemployment rate.

At a speakers’ dinner last week, we visited with several leading economists. Their consensus was that unemployment would remain over 7% for the next 10-15 years. If their numbers are correct, economic growth may suffer for a generation.

“Where Shall I Go? What Shall I Do?” Scarlett O’Hara

Slower domestic growth does not mean that growth will be slow everywhere. A middle class is exploding in China as thousands of new cars hit the already choked streets of Beijing each week. Brazil is growing too. Multinational blue-chip companies based in the US will have to invest in their businesses in order to keep up. The hope for US investors shifts to foreign growth and global demand. This doesn’t mean that investors have to start picking stocks on foreign exchanges; large-cap multi-national companies will participate.

Low interest rates and the cheap money they provide create a powerful environment for mergers and acquisitions. Biotech companies, airlines, and others have already begun the process. These mergers streamline operations and create efficiencies, but they also eliminate jobs. The greater cash flow they generate can fund additional acquisitions or future dividends for shareholders.

"Slower domestic growth does not mean that growth will be slow everywhere." -Farr, Miller & Washington , Michael Farr

Valuations for large blue-chip companies are reasonable in spite of recent gains. The yield on the S&P 500 is 1.98%, which is 65% higher than the current yield of a 5-year US Treasury. And speaking of Treasuries, we wish folks would speak of them less often than they do and with a good deal less enthusiasm. At the height of oil fury, with prices over $140 per barrel, one could understand the hyper-hopeful’s dreams of $300 a barrel. It is impossible to understand potential gains from a 2.5% 10-year US Treasury Note. There will likely be some very disappointed investors.

Warren Buffet says that Americans are funny in that they love stocks when they’re expensive and hate them when they’re cheap. Bill Miller says that everyone wants to buy whatever has been working for the past five or six years and sell whatever hasn’t. Be assured that bonds have been working. They have outperformed stocks for the past ten years. This is an historical aberration and not likely to continue. Pay attention to the huge flows of money leaving stock funds and buying bond funds. It has been feverish this year and may end unhappily for those following the herd into bonds.

We remain cautious in this environment. High quality blue chip stocks remain reasonably priced, but investors aren't buying these stocks. We have not seen the type of rotation into high-quality, defensive companies that we usually see when the economic backdrop becomes clouded. Rather, investors simply wait for the Fed to signal action and then they jump in with both feet. This is not investing - it's trading. We are confident that market will ultimately return to an "investor's market."

Until then, we will stick with our knitting.


Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.