Magicians say "abracadabra" to conjure up a miracle. Central bankers say "quantitative easing."
Those two words explain the current rally in global stocks, which began a month ago when they were uttered by the Federal Reserve. They mean the Fed intends to flood the marketplace with money, and it isn't acting alone. Central banks in Japan, Great Britain, China and Switzerland have announced the same goal.
Easy money is a reliable predictor of economic growth. The current recession is the product of a credit seize-up that began two years ago, a period with money so tight as to be nonexistent. The central bankers acted because when money is so tight that it cuts off spending, deflation results. And that way lies depression.
So praise the Lord -- and pass the ammunition. The inevitable result of quantitative easing is inflation, because easy money is hard to shut off. Inflation is toxic to bonds, which have been investors' only reliable friends for more than a decade. But one type of bond is inoculated against inflation, and it is becoming the most sought-after bond of all.
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Treasury inflation-protected securities, or TIPS, actually benefit from rising prices and will deliver outstanding results when inflation begins to heat up as global growth is restored. "We could easily see these double over the next 12 to 18 months," says John Brynjolfsson, the author of "Inflation-Protection Bonds" and the chief investment officer of Armored Wolf, a hedge fund in Aliso Viejo, Calif.
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TIPS are easy to buy in the form of mutual funds and exchange-traded funds, and they are cheap. The average one in the Morningstar (MORN, news, msgs) database is down 4.7% in the 12 months that ended April 8. But savvy investors are beginning to buy them, and they're ahead 3.3% in the past month.
"We started buying these aggressively last December, when they were extremely distressed, and we remain constructive on the asset class. They are cheap insurance against inflation," says Mihir Worah, the manager of Pimco Real Return (PRTNX), one of the largest, and best, TIPS mutual funds.
Opening the floodgates
Last year's credit crisis effectively sealed shut the wallets of the world's banks. There were times when they were unwilling to lend even to each other for periods as brief as overnight. But without borrowing, businesses can't buy inventory, and consumers can't buy houses. The prospect was a global economic catastrophe.So government has thrown its considerable heft behind stimuli. Consumers have focused on fiscal policy, such as massive spending on public works. Investors, however, have focused on monetary authorities. They can print money in virtually unlimited quantities, providing so much liquidity that borrowing can resume and economic growth can follow.
In March, the Federal Reserve publicly announced a policy of quantitative easing, or massive money creation. Although the European Central Bank has not been as aggressive, many other governments have, and the positive response of investors has been global.
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Just as massive money growth reliably translates into economic stimulus, a declining expectation of deflation is also positive. People don't spend when they expect prices to be lower tomorrow. When they expect them to be higher, though, it makes sense to spend today.
Brynjolfsson says the Fed is targeting an inflation rate in the range of 4% to 6%, which it should hit within two years. However, he says, "I expect that goal will be overshot, with inflation heading to 10%, very possibly."
The Fed is nominally independent of politics, but in reality it answers very directly both to Congress and to the president. The opposite of quantitative easing is quantitative tightening, as in raising interest rates. A Fed chairman of years ago noted that his job was "to take away the punch bowl just as the party gets going." That's a job the Fed will have a hard time doing when the world is emerging from the current vicious slump.
Continued: Different bonds, different directions
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