Wednesday, March 18, 2009

Fed's Actions Induce Rally

Stocks surged immediately following the Fed's press release today. In perhaps its boldest action to date, the Fed said it would significantly increase the size of its balance sheet by buying up to $750 billion of mortgage-backed securities, up to $100 billion more of agency debt, and up to $300 billion of longer-term Treasury securities. In other words, it will flood the market with money.

The Fed has come under criticism is recent weeks for tightening the money supply. Steve Forbes, for example, recently pointed out that despite lowering short term interest rates, the Fed's balance sheet has actually shrunk by almost $400 billion since December. Today's decision reverses this trend.

Despite today's actions, investors know that the economy will not improve until housing prices stop falling. What the Fed announced today should support housing prices by reducing mortgage rates, but that may not be enough to generate sufficient demand. After all, housing inventories are still too high, and mortgage rates are just one component of the cost of buying. As I've discussed on this blog many times before, property taxes represent a major cost of owning a home and there is nothing being done to address this problem.

I continue to believe this is an excellent time for long-term investors to be buying equities. Those who are willing to wait five to ten years should not hesitate to get in now. Nonetheless, I also think there is a reasonable chance we will see another significant selloff in stocks in the near term. If we are lucky, the recession will be over by yearend. However, there is more bad news to come. With corporate profits falling and unemployment rising, we are still a long way from being out of the woods.