It's no secret that Wall Street is buzzing about one thing and one thing only right now: quantitative easing, or QE as it's known. The market was clearly shaken last week when Federal Reserve Chairman Ben Bernanke indicated in his Congressional testimony that the central bank may start to ease up on its economy-boosting stimulus program, provided that data continues to show improvement in the U.S. economy.
Of course, the release of the Fed's April meeting minutes later in the afternoon also showed a good deal of disagreement among Fed officials, so Mr. Bernanke may have been trying to be flexible in his approach. There are some who think the Fed was launching a "trial balloon" to see how the news would be received, and that they are not yet ready to scale back on the stimulus. However, I think that if we continue to see job gains in the range of 175,000 to 200,000 per month, we could see some tapering by the end of the summer.
Just the speculation about when QE might end has raised in interest rates. Stocks were weak Tuesday afternoon and Wednesday morning, when the yield on the 10-year Treasury bonds moved up to 2.17%. To give some perspective, the 10-year yield was as high as 3.75% as recently as February 2011, when we were in midst of QE2. So if the Fed does indeed cut back on QE3 in the near term, we may have just caught a glimpse of what could be a sharp rise in rates.
What does a rise in interest rates mean for investors? Turn on any financial news station and you'll hear analysts claiming that any rise in interest rates will be offset by gains in earnings from a stronger economy. While this is true to an extent, it's also somewhat simplistic.
A good part of the market is comprised of companies whose earnings are not especially economically sensitive, such as utilities, healthcare and consumer non-durables. After all, people still need electricity and healthcare whether the economy is good or bad. Many stocks in these groups have been considered safe havens due to their earnings stability and have therefore outperformed dramatically this year. In turn, they would be vulnerable to higher rates, given that any earnings boost from the improved economy would be minimal. In addition, the housing market could potentially suffer from an increase in interest rates, which would in turn hurt the results of many economically-sensitive companies.
We all know that QE cannot go on indefinitely and has to end sometime. With the market up around 16% this year largely on the strength of QE, we should expect to see some additional volatility as the idea of an end to the Fed's backing becomes a reality.
So where will I be investing? I will continue investing in game-changing companies that have strong growth catalysts and can continue to grow regardless of whether QE is still in place.
One company that I think will do well is Intercept Pharmaceuticals (ICPT). This company focuses on the development and commercialization of treatments for chronic liver disease. It's most advanced programs are focused on the development of modified bile acids that can regulate key aspects of liver functionality through receptors. Its leading product candidate, obeticholic acid (OCA), has been developed to treat primary biliary cirrhosis (PBC), which is a rare and chronic autoimmune liver disease that, if inadequately treated, may eventually lead to cirrhosis, liver failure and death. This stock moves on news of its drug trials, not the latest QE buzz, and it should continue to get a boost from any updates management reports.