The Federal Reserve’s decision last week to initiate “QE Infinity” has investors understandably uneasy as to what this unprecedented government intervention means for the U.S. economy and investments. QE Infinity entails the open-ended purchasing of $40 billion in mortgage-backed securities each and every month until the U.S. labor market “improves substantially.”

It would be nice to know what “substantial improvement” means, whether it be a 6% unemployment rate, average job growth of 250,000 per month, or something else. Unfortunately, Fed Chairman Ben Bernanke refused to quantitatively define “substantial improvement,” leaving this labor concept in the same quagmire as pornography – about which former Supreme Court Justice Potter Stewart famously proclaimed in 1964: “I know it when I see it.”

As for the economy, the Economic Cycle Research Institute (ECRI) recently stated that the U.S. economy is already in recession, even though quarterly GDP growth has not yet turned negative. Never mind that the Nasdaq is at a 12-year high, the Dow Jones Industrials are at a 5-year high, or that the S&P 500 is at a four-year high. Stocks do not always anticipate recessions. In three of the 15 recessions since 1926 (i.e., 20% of the time), stocks actually rose (1926-27, 1945, 1980). Stocks arguably have risen because of the Fed’s quantitative easing, which lowers interest rates and raises equity valuations, and not because of economic strength. Indeed, just today express-mail company FedEx (NYSE: FDX) announced that the global economy is worsening and 2013 will be weaker than 2012.

On the other hand, according to Bloomberg, whenever the S&P 500 has risen by more than its 11.9% average gain during presidential election years since 1948, U.S. GDP growth has accelerated in the following year. With the S&P 500 up 17% year-to-date, it has gained 5.1% more than the 11.9% average and this suggests the economy next year will be okay. Of course, 2012 is not over yet and a big downswing in stock prices below the election-year average could still occur.

As for investments, look for individual companies and asset classes that benefit from a weak U.S. dollar, low mortgage rates, higher commodity inflation, and higher long-term U.S. Treasury rates. Since QE Infinity will focus on mortgage-backed securities (MBS) and not U.S. Treasuries, it is very possible that the interest rates on these two types of fixed-income instruments could diverge. Bond king Bill Gross recently tweeted:

Sell bad bonds, buy good ones. Investing sometimes can be very simple.

This economic forecast sounds a lot like stagflation!

Best Stocks for QE Infinity

As I wrote more than two years ago in Best Asset Classes for Stagflation, weak economic growth combined with increased inflation favor:

• Commodities like gold (NYSE: GLD), coal (NYSE: KOL), crude oil (NYSE: DBO), and agricultural fertilizer (NYSE: MOO)
• Foreign emerging markets (NYSE: VWO)
• Large U.S. multinational exporters that benefit from a weak U.S. dollar (FEXPX)
• Dividend stocks (NYSE: DVY)
• Small-cap growth stocks (NYSE: IWO)

To that list let me add mortgage REITs (NYSE: REM) which purchase MBS – thus benefitting from the Fed’s $40 billion per month buying binge — and lever up these MBS investments 10-to1 by borrowing cash at short-term interest rates – thus benefitting from the Fed’s extension of its zero-interest-rate-policy (ZIRP) until mid-2015.

Worst Stocks for QE Infinity

Losers would be companies whose input cost structures rely heavily on commodities, such as trucking companies, airlines, cereal manufacturers, jewelers, and restaurants.

Stock Screen

I ran a Bloomberg screen for stocks that have performed particularly well and particularly poorly since the Fed’s QE Infinity announcement on September 13^th. Sometimes it is useful to see what the market has actually determined to be the winners and losers and not just what some pundit (e.g., me) speculates will happen!

Best-Performing Stocks: 9/12/12 to 9/17/12

Worst-Performing Stocks: 9/12/12 to 9/17/12

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