Whatever “quantitative easing” is, it sounds like something you probably only need to pay attention to if you’re a politician—after all, you’ve got enough to worry about, like paying your mortgage and working on growing your retirement account.
But what if we told you that the looming end of quantitative easing could mean a sudden drop in the value of your investment portfolio? That would probably perk your ears up, wouldn't it?
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Even if you’re the type who reads The Wall Street Journal for fun, you might not realize the impact macroeconomic headlines could have on a microeconomic level—in other words, your own money.
"It's easy for consumers to gloss over stories about the economy,” says Dan White, a Philadelphia-based financial analyst. “There is fatigue when it comes to the constant repetition of these terms that are less-than-well understood. So much of it is the disconnect between how these stories impact the markets and how they impact the average worker in their day-to-day lives."
So we've put together a plain-English crib sheet on some of the biggest financial buzzwords you may have heard in recent months and how it all potentially impacts your money. Consider it your current events lesson of the day.
1. The End of Quantitative Easing
The basics: After the height of the financial crisis in 2009, the Federal Reserve instituted quantitative easing (QE)—an unconventional monetary policy in which the government buys short-term bonds from banks in order to help inject money into the economy. The goal of this influx is to beef up banks’ reserves, which then should decrease interest rates, promote lending and stimulate spending.
QE came about because the Fed’s usual method of stimulating the economy by lowering interest rates alone didn’t seem like enough to spark a recovery. “What happened to our economy in 2008 was so severe that [the Fed] did everything they could to make rates near zero,” explains Kim Caughey Forrest, vice president and senior equity analyst at Fort Pitt Capital Group. “But that didn’t work too much, so they came up with something called quantitative easing, and bought bonds.” The Fed has completed multiple rounds of QE since the crisis.
In July the Federal Reserve Chair, Janet Yellen, announced that the Fed expects the economy to show signs of recovery, so the central bank would start tapering back quantitative easing from about $35 billion a month now to nothing by October. Critics of QE say it hasn’t stimulated the economy in the way it intended to, and has outlived its effectiveness.
Why it should matter to you: Quantitative easing, generally speaking, has kept the stock market stable. Because interest rates have stayed so low for so long, people may be more inclined to apply for loans and purchase such big items as homes. However, with the government’s plan to end QE on track, there is fear that the stock market may become more volatile once it ends. Without some kind of stability, you could see the value of your 401(k) or other investments drop in the short term.
Also, some market watchers think that interest rates will likely go up after QE ends, even though the Fed has not indicated as such. “If interest rates rise, people will not be able to borrow as much money. And if they can’t borrow as much, they can’t spend as much,” says Robert S. Rycroft, a professor of economics at the University of Mary Washington. “And it’s people spending money that creates jobs.”
And while White reassures that “the world is not going to end” when QE does, it is likely to have some impact on the economy, whether that could mean a more volatile stock market or potentially lower bond prices due to rising interest rates. Those who are close to retirement may have to carefully decide if they should rebalance in order to maintain a diversified portfolio that they feel comfortable with and that works for their timeline.
2. Ballooning Student Loan Debt
The basics: Student loan debt is rising like crazy. A recent Pew Research Center analysis of government data reveals that nearly four in 10 U.S. households headed by an adult younger than 40 has some student debt. The class of 2014, meanwhile, graduated with an average of $33,000 in student loans, adding to the approximately $1.2 trillion of debt that the U.S. already carries.
All of this should come as no surprise, considering the cost of higher education outpaces inflation. Add to this the fact that the type of qualified costs you can borrow student loans for has expanded, and you’ve got a lot of grads learning a tough lesson. “When I went to school, I borrowed $5,000. At that time, you couldn’t borrow for books, you couldn’t borrow for lattes, you couldn’t borrow for cost of living,” Forrest explains. “People may not understand what borrowing that amount means. And, right now, the government is taking on many of these loans.”
Emerging markets—countries like Brazil, Russia and South Africa—make up more than 50% of the world’s gross domestic product. So they're contributing more to the global economy than developed nations, like the U.S.
Why it should matter to you: If enough people around the same age have too much debt, it could have bad implications for our economy. “It slows the likelihood of them being able to move out of their parents’ house, to get married and have children, or take out another loan to buy a house,” Forrest says. In fact, investment in residential housing is the lowest it has been since World War II because so few young people are financially ready to take the step and form new households.
“You’ve got kids graduating with $80,000 in debt working at Bennigan’s,” says White, adding that large debt burdens can contribute to competition for higher-paying jobs. “These are the years when college graduates should be spending money. If they’re not contributing to the economy and not spending, it's a drag on economic growth.”
There’s also the issue of what happens if all of those federal loans don’t get repaid. “If somebody [in the government] decides ‘there’s too much debt out there, we’ll forgive their loan,’ that means the taxpayer may have to pay that,” Forrest says. And if taxes don’t rise to shoulder that added burden, services such as Medicare could potentially be cut or reduced.
3. The Rise of Emerging Markets
The basics: The term “emerging markets” refers to developing economies, often in still underdeveloped nations, that are experiencing rapid growth. Recent data from the International Monetary Fund revealed that, for the first time, emerging markets—countries like Brazil, Russia, South Africa and Mexico—make up more than 50% of the world’s gross domestic product. So what this means is that they're collectively contributing more to the global economy than developed nations, like the U.S.
Many analysts believe the future of global growth will be in emerging markets, which may in turn provide opportunity and competition for businesses here in the States.
Why it should matter to you: There are pros and cons for the U.S. economy when it comes to the growing power of emerging markets. For example, the big loss in manufacturing jobs, especially during the first half of the decade, was due in part to companies sending their operations overseas.
“There’s a large supply of people outside the U.S. who are willing to do manufacturing jobs for a fraction of the cost,” explains Josh Alpert, a financial adviser and C.E.O. of Wealth Trac Financial. “There’s a trade-off, obviously. For example, there hasn’t been an electronics manufacturer [in the U.S.] in years because the cost could be outrageous and consumers probably wouldn’t pay the price.”
On the flip side, there is a rapidly growing emerging middle class in these countries that's hungry for all types of products. This gives U.S. companies—and their shareholders—lots of opportunity to engage in untapped markets. Case in point: The auto industry is starting to bring jobs back to the U.S. to help meet a high demand for cars in certain emerging markets.
And if you're thinking of investing in emerging markets as a way to diversify your portfolio, it's wise to note that these regions offer the potential for fast growth, but also carry some risk because of their less-stable economies and political environments.
4. The Gold Rally
The basics: Gold, silver and other precious metals are often viewed as a safe investment haven when the stock market gets volatile, so investing in these commodities could be a way to help spread some risk in a portfolio.
Precious-metal prices often fluctuate based on market volatility, inflation fears and political instability. In the second quarter of 2014, for example, gold and silver prices continued to dip as the economy strengthened, but more recently, gold experienced a rally partly due to the troubles in the Ukraine and Gaza. “During turmoil and uncertainty, people buy a ton of gold and silver,” Alpert says.
Why it should matter to you: You probably don’t think about the price of gold or silver unless you're going to buy jewelry. But precious-metal prices can be a sign of bigger trends. When metal prices go down because demand goes down, this could be an indication that people are investing more of their money in equities, a.k.a. the stock market, says Alpert—which can be good for the economy. Conversely, if metal prices go up, it may be a sign that investors are concerned about market volatility and a weakening dollar.
If you invest in gold, such as through an exchange-traded fund, it’s also good to know that interest rates and gold prices generally have an inverse relationship, although there are lots of factors that affect the price of precious metals. With the end of quantitative easing, it’s possible interest rates could rise, which means gold prices may go down.
5. The Price of Pork Bellies
The basics: Another iconic commodity is pork bellies, which is exactly what you think it is—the part of the pig used for bacon and, in recent years, the meat lover’s mainstay at the country’s trendiest restaurants.
Until 2011, pork bellies were traded on the Chicago Mercantile Exchange futures market. Meat manufacturers would purchase futures contracts on pork bellies so they could lock in their future cost and help protect themselves against spikes in prices, explains Rycroft.
But that only made sense when pork bellies were frozen and sold in units mostly during barbecue season in the summer. Once bacon and other pork-belly products became more common year-round, their prices became more volatile, which basically killed interest in pork-belly futures.
It’s important not to let the market’s ups and downs drive you into a panic, since investors who pull out of markets too quickly may not be able to take advantage of later potential gains.
Why it should matter to you: Although their heyday on the futures exchange has passed, pork bellies became a sort of comical but lasting representation of the futures market in general. And futures contract prices are good to follow because they are usually a long-range warning signal of what might happen to the prices of specific commodities—like wheat or oil—based on supply and demand. And this could have a trickle-down affect on your cost of living, says Rycroft.
Also, watching the price of pork and other meats can be a good indicator of what you may be paying not only in grocery stores but also at your favorite restaurants. A recent pig virus that lowered pork supplies in U.S., Mexico and several other countries this summer has been driving up prices for pork—which, in turn, has meant consumers have been paying more for the bacon they eat for breakfast in the morning.
6. Overextended Equity Rallies
The basics: An “equity rally” refers to a massive buy-up in stocks that results in a continuously rising stock market, also known as a bull market. Thanks to the aforementioned quantitative easing, the current bull market has been going on for a while—a little too long, some analysts say, hence labeling a rally as “overextended.”
And what goes up usually comes down.
“Since the 2012 election, the stock market’s gone straight up without any normal corrections,” says Mike McGlone, director of research at ETF Securities. A typical correction is considered a loss of 20%, but there haven't even been any 10% corrections since 2012, he adds.
Why it should matter to you: In the past, when the stock market has gone up too fast without any corrections, it’s been followed by an even bigger, more sustained correction, says McGlone. “We all know what a free lunch is—something that will not last much longer," he says. "So we’re bracing for a potential crash.”
If we do have a correction, it may be a big one, considering both the Dow Jones and the S&P 500 indexes have broken all kinds of records this summer. McGlone likens the current market environment to the one preceding the stock market crash of 1987. In the first half of that year, stocks saw an enormous run-up, but on October 19—dubbed “Black Monday”—the stock market experienced the largest one-day loss in history.
Of course, it’s important not to let the market’s ups and downs drive you into a panic, since investors who pull out of markets too quickly may not be able to take advantage of later potential gains. For example, investors who pulled out of stocks after the recession missed out on last year's rally, when the market saw some of the largest gains since the mid-1990s. That said, if you can’t stomach market volatility, remember that having a diversified portfolio can be one way to spread out your risk.
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