BOSTON (AP) - Expect investing to get more uncertain starting next month, and potentially less rewarding.
That's the warning from pros who are preparing for slightly more volatile markets when the government's latest government stimulus program ends. Next Friday will be the last day of a Federal Reserve program dubbed QE2, short for quantitative easing, round two.
The first such bond-buying program began in March 2009, when the stock market bottomed out near the end of the Great Recession. In the second round, begun last November, the Fed bought $600 billion in Treasury bonds.
Now, the biggest buyer of those government IOUs will play a new role: Eventually, it will sell those bonds back to the market.
Investors have anticipated that shift for months. Yet the program's end is making some money managers more cautious because of the greater uncertainty it creates.
The Fed expanded the pool of buyers for Treasurys by purchasing around $75 billion of the bonds each month, starting in November. The purchases helped reduce Treasury yields, making them unappealing for any investor seeking a decent return. Yields for 10-year Treasurys, for example, have recently slipped below 3 percent. This has helped prompt investors to seek out other assets, such as stocks and higher-yielding corporate bonds, whose prices have rallied since the recession.
"QE2 has been a pretty big source of demand for riskier assets, and with that going away, that's one of the reasons we're cautious now," says Mike Buckius, co-manager of the Gateway Fund, a $5 billion stock mutual fund.
He expects greater volatility in the stock market this summer. It's a key reason why Gateway's portfolio is packed with stocks of large, stable companies that tend to hold up better than smaller ones when things get bumpy. The portfolio's top 10 holdings include such dividend-paying stocks as ExxonMobil, Pfizer and IBM.
Here's a look at key trends money managers expect in coming months as the effects of QE2 wear off:
- Stocks:
The stock market is all about expectations, and prices generally move months before anticipated developments in the economy actually play out.
It's been known for months that QE2 would cease on June 30, so the market has likely priced in the program's end. Many think that's a key reason stocks declined six straight weeks starting in May, in addition to factors such as growing worries about Greece's debt crisis.
"Are we going to have a big market meltdown on June 30 because that is the day QE2 ends? No," says Kent Croft, co-manager of Croft Value, a $404 million stock mutual fund.
Without QE2, it is likely stock prices would not be as high as they are today, says Bob Doll, chief stock strategist with asset manager BlackRock Inc.
"However, this does not mean that when QE2 ends stock prices will go down," he says. "It merely means there will be one less positive tailwind for the markets."
- Bonds:
Marilyn Cohen, a manager of $325 million in bond portfolios for clients of Los Angeles-based Envision Capital Management, says the end of the Fed's Treasury purchases should eventually drive up yields. Other investors may be unwilling to buy Treasurys at their currently low yields, unless prices for stocks fall, driving investors into the perceived safety of government debt.
Cohen will closely watch Treasury auctions to see whether adequate demand exists to keep yields low. She expects volatility, as investors assess a new Treasury market without the Fed as a buyer.
"It will take multiple auctions before we know who the natural buyers of Treasurys will be, since the unnatural buyers (the Fed) will be stepping aside," Cohen says. "All you need is two lousy back-to-back Treasury auctions, and then it will be, "Look out, below."'
- Economy:
Many economists credit QE2 for heading off the threat of deflation - a destabilizing drop in wages, the prices of goods and services, and the value of stocks, homes and other assets.
However, critics fear QE2 and other stimulus programs have increased chances of long-term inflation. That hasn't happened yet, although there was a rise in oil and gas prices early this spring - a factor that helped trigger the recent slowdown in the economic recovery. Prices have recently slipped below $4 a gallon, but remain high, with the current national average at $3.60.
Nathan Moser, manager of the Pax World Small Cap Fund, says QE2 is partly to blame for pricey gas, and could fuel inflation for other goods and services down the road.
That's because the Fed's bond purchases flooded financial markets with dollars, diluting the dollar's value against other currencies. That attracted foreign buyers to oil, because the commodity is priced in dollars. Because oil became a relative bargain for those buyers, demand rose, which led to higher prices in global oil markets, and at the pump.
That has stretched budgets and hurt consumers, who generate about two-thirds of all economic activity.
With QE2 ending, the dollar's value is expected to rebound against other currencies, which could ease the risk of higher oil prices.
If the Fed launches another round of stimulus - QE3 - Moser worries the dollar will again drop and oil will rise, hurting consumers and the recovery.
He says it's time for the Fed to let the economy stand on its own, even if it means continued slow growth. On Friday, the government reported that the gross domestic product - the economy's total output of goods and services - grew at a 1.9 percent annual rate during the first three months of the year. Historically, growth has averaged about 3 percent.
Moser expects the economy will continue expanding at a relatively slow pace the rest of the year: "We have to take our medicine, and muddle through."