Boiling Point: Spot Checking QE2

February 14, 2011

With inflation hurting emerging markets and the U.S. yield curve sending mixed signals, it may be too soon to label the current path 'sustainable.'


In January’s Racing To The Cliff?, I highlighted how I might have been overly skeptical of the stock market’s rally and the economic recovery overall. Since Sept. 30, when I reasoned the risk didn’t justify the reward, the S&P 500 has climbed more than 17 percent and the Russell 2000 over 20 percent. Emerging markets, however, have been flat to down over that time frame amid increasing inflationary pressures.

IU_ChaddBennettThe premise I laid out then is still intact based on the fact that much of this inflation has been caused or exacerbated by the very same policies that are lifting the U.S. markets. Specifically, tax cuts that are adding to the federal budget deficit, plus the Fed’s “quantitative easing,” highlight my concerns that policies designed to stimulate the economy could now be counterproductive.

A murky picture emerges when you look at performance of different parts of the market from the end of September, when markets began pricing in the QE2-related Treasury purchases. As the table below shows, developed countries including the U.S., Germany and Japan, have all dramatically outperformed their emerging market peers over this time frame.

The iPath MSCI India Index ETN (NYSEArca: INP) and iShares FTSE China 25 Index Fund (NYSEArca: FXI) are actually down 15 and 2 percent, respectively, over that time frame. Brazil, represented by the iShares MSCI Brazil Index Fund (NYSEArca: EWZ) has also been relatively weak as South America’s biggest economy steps up efforts to cool inflation as well.


Symbol Description 9/30/2010 2/11/2011 %
BAL iPath Dow Jones-UBS Cotton Subindex Total Return ETN 49.99 96.21 92%
$TNX US Treasury 10-Year Yield 2.51 3.64 45%
SLV iShares Silver Trust 21.31 29.21 37%
$TYX US Treasury 30-Year Yield 3.68 4.71 28%
DBA PowerShares DB Agriculture Fund 27.48 34.83 27%
$COPPER Copper Futures 365.15 453.6 24%
IWM iShares Russell 2000 ETF 67.5 82.07 22%
EWG iShares MSCI Germany Index Fund 22 25.94 18%
CRB Reuters/Jefferies CRB Index 286.86 337.78 18%
SPY SPDR S&P 500 ETF 113.53 133.11 17%
EWJ iShares MSCI Japan Index Fund 9.82 11.32 15%
$WTIC Oil - Light Crude - Continuous Contract 80.03 86 7%
EWP iShares MSCI Spain Index Fund 39.45 41.4 5%
GLD SPDR Gold Trust 127.91 132.32 3%
EWS iShares MSCI Singapore Index Fund 12.92 13.35 3%
VWO Vanguard MSCI Emerging Markets ETF 44.68 45.92 3%
$USD US Dollar Index 78.72 78.4 0%
FXI iShares FTSE China 25 Index Fund 42.65 41.68 -2%
LQD iShares iBoxx $ Investment Grade Corporate Bond Fund 110.91 107.59 -3%
EWZ iShares MSCI Brazil Index Fund 74.35 71.9 -3%
EMB iShares JPMorgan USD Emerging Markets Bond Fund 109.02 104.58 -4%
INP iPath MSCI India Index ETN 75.76 64.45 -15%
$VIX CBOE Volatility Index 23.7 15.69 -34%


The basic story above is that commodities are taking off and developed markets are well-bid, but emerging market equities are getting left behind as inflation—and concern about more of it—starts taking a bite. The inflationary challenges emerging markets have faced is clear in the chart below. It shows the outperformance since the beginning of November of the Thomson Reuters/Jefferies CRB commodity index over the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM), the most liquid emerging markets ETF.


$CRB:EEM as of 2/11/11



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