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When Will QE3 Rally End? Watch the CPI

NEW YORK ( AdviceIQ) -- What do the twin announcements of Federal Reserve and European Central Bank stimulus mean to investors? In the short run, stock rallies. In the long run, inflation, perhaps more than is comfortable.

My advice is to ride the market for now, but keep an eye on the consumer price index. Then get defensive.

Last week, Chairman Ben Bernanke kicked off a third round of stimulus, otherwise known as Quantitative Easing, or QE3. This time, we're not just talking about another extension of "Operation Twist," where the Fed sells short-term Treasuries, then turns around and buys long-term Treasuries. This is serious business here. In addition to the extension of Operation Twist, and the promise to keep interest rates close to zero through mid-2015, Bernanke announced plans to buy $23 billion of mortgage-backed securities through the end of this month, and then $40 billion each month, until employment improves.

The first two rounds of easing were worth a staggering $2.3 trillion, and the Fed is still increasing the total money supply -- now in the mortgage-backed security (MBS) arena, as I'd expected. This time, the easing is open-ended. The Fed is going to keep buying mortgage-backed securities until the medicine works.

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The markets skyrocketed on Bernanke's announcement, echoing its response to a similar plan from the European Central Bank. Earlier this month, ECB head Mario Draghi announced a plan for unlimited, conditional bond buying for countries in Europe who ask for the help. This means that any country that wants to sell bonds to the ECB can simply ask, and Draghi will oblige. The ECB's previous buying of sovereign bonds has already driven down borrowing costs for those troubled countries.

Of course, these policies by the world's two biggest central banks aren't universally accepted. The Fed's critics, like myself, point out that when the total number of dollars in circulation increases, the value of all the dollars in the system decreases, which could result in disastrous inflation, effectively punishing savers. As for the ECB, some central bankers don't think that direct bond-buying falls within the bank's mandate. There is also no guarantee that these already-indebted countries will actually pay back the ECB when the bonds mature.

Instead of debating whether these central bank actions are good or bad in the long run for the global economy, I'm looking at ways to use the news to make money in our portfolios in the short term. I believe the markets both here and overseas are going to see some positive movement over the coming months and that those sitting on the sidelines should be wary of letting their emotions get in the way of adding risk now.

In response to the Fed announcement last week, I removed a good portion of the defensive hedges I implemented over the past couple of months. There are plenty of investments available, but just like eating at a restaurant, the trick is not ordering just anything off the menu. We have to be selective about the type of investments and sectors we buy. Just as importantly, we have to time our investments well. Being right at the wrong time is simply wrong.

I think that there will likely be little pullbacks in the markets over the coming months. And even more likely: One or two mini-corrections that arrive sooner than later, due to the culmination of options and futures expiring at once. But I feel these pullbacks should be treated as opportunities to buy into new positions at discounted prices rather than signs that the markets are falling apart.

On top of all of this, China is following suit with stimulus actions of its own. All of these actions might burnish the global economic picture for a while, but the future is still uncertain. Up ahead, we will strategically target our investments geographically to contend with the coming wave of inflation.

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-- By Adam Koos, founder and president of Columbus, Ohio-based Libertas Wealth Management Group, for AdviceIQ

AdviceIQ is a network of financial advisors that writes insightful articles for the public about investing and wealth management. All articles are edited by AdviceIQ's editor in chief, Larry Light. AdviceIQ certifies that all its advisors have no regulatory infractions.

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