How To Prepare For QE3

Whether you ever agreed with the unconventional policy from the Federal Reserve, there’s no denying that ETF investors stand to benefit.

And, let’s face it—it was only a matter of time before we got here.

After QE2 played out—ending just about a year ago—Europe’s problems have dominated headlines and the market forgot about all those “green shoots.”

Now many observers are openly discussing whether Greece should stay in the European Union, while at the same time economic data from China points toward a slowdown.

All but sealing the deal for further quantitative easing was last week’s U.S. jobs numbers.

With unemployment now at 8.2 percent—up from 8.1 percent in April, and a presidential election looming—it’s not unreasonable to prepare for some easing from Fed Chairman Ben Bernanke.

QE Winners

There’s no doubt that equities stand to benefit the most from a new round of quantitative easing.

The SPDR S'P 500 ETF (SPY - News) comes to mind first, but let’s look at things more broadly.

Total U.S. equity market performance wasn’t too shabby after QE2 was started.

In fact, from the moment QE2 was announced in November 2010 till the end of the program in June of last year, the Vanguard Total Stock Market ETF (VTI - News) was up 12.63 percent, while SPY was up 11.34 percent.

Gold was another clear winner. The past year has been lackluster for the yellow metal, but should the Fed decide to pump more money into the system, the gold bulls will be returning strong.

During QE2, the SPDR Gold Shares ETF (GLD - News), the world’s biggest bullion ETF, was up 10.67 percent.

In fact, as of last Friday, gold already started making some serious moves that seem to align with expectations of QE3.

After the disappointing jobs numbers, GLD rallied nearly 4 percent on the day.

It’s still debatable how suitable gold is as a hedge against inflation, but it seems unlikely that we wouldn’t see some strong spikes in gold should “Uncle Ben” make a move.

I hate to say it considering the way I see people rejoice at the falling prices at the gasoline pump these days, but QE3 definitely means higher prices for oil—and commodities in general.

Many wanted to blame speculators for the rise in oil prices last year, but really, QE2 played a huge role in the process.

Luckily, investors can still benefit.

My commodity fund of choice, the PowerShares DB Commodity Index Tracking Fund (DBC - News), was up a whopping 14.29 percent by the end of QE2 in June 2011, and was as much as 25 percent higher in April 2011.

DBC is down nearly 8 percent year-to-date. However, like gold and equities, it’s hard to argue that DBC is close to a perfect tool to take full advantage of a general pop in commodity prices.

A Bond Bust And A Dollar Downer?

Unsurprisingly, bond prices would probably take a hit from new quantitative easing.

Let’s be honest. U.S. Treasurys have had the longest streak of weekly gains in more than 13 years. Now we have 10-year Treasury note yields trading as low as 1.44 percent. Eventually, something’s going to give.

With investors rushing deep into bonds, there’s no doubt that another round of quantitative easing would bring some pretty strong reversals to the price gains we’ve seen recently.

In the graph above, the iShares Barclays Aggregate Bond Fund (AGG - News) was down only 1.44 percent during QE2.

However, ETFs with greater interest-rate risk will take a much harder hit. The iShares Barclays 20+ Year Treasury Bond ETF (TLT - News), for example, fell by more than 4 percent in that same period.

Another loser, should QE3 come to pass is, unsurprisingly, the dollar.

You can only pump so much free money into the system without the greenback taking the fall.

During the second round of quantitative easing, the PowerShares DB US Dollar Index Bullish Fund (UUP - News) was down 5.31 percent. You could short UUP, or you could easily buy its sibling, the PowerShares DB US Dollar Index Bearish Fund (UDN - News).

There’s no guarantee that we’d see the same results in a third phase of quantitative easing that we saw during the second phase.

But at this point, the market is hooked on help from policymakers and looking for another fix.

You may not agree with how the patient is likely to be treated, but it doesn’t mean you can’t profit from it.

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