How to Trade the Fed's Action
The Bloomberg headline reads Fed Bond Buying May Risk Price Rise Similar to 2004. Let's remember that between 2004 and 2007, the S&P 500 rose around 40%, from approximately 1,100 to 1,550.
I think we would all be pretty pleased with a move like that.
Of course, the rise in the S&P 500 coincided with the housing bubble and the proliferation of sub-prime mortgages that led to the financial crisis of 2008-2009.
But I think it's worth considering where that bubble actually occurred. Was it solely at the home price level? Or should we consider the insane expansion of "no doc" and "no interest", and the subsequent boom in mortgage-backed securities, the real bubble that destroyed the economy?
Because while the rise in home prices may have proved unsustainable, it was the poor credit quality of millions of new loans that sent the housing market into overdrive and crushed the banks.
It's a worthy debate. Though I would point out that I am not in favor of bubble blowing to rejuvenate the economy. But, since the government and Congress does not seem interested in putting the conditions for growth in place, the Fed is doing what it can.
And what the Fed can do is boost asset prices, like bonds and stocks.
The Fed can be successful at driving the relative value of the dollar lower. That, in turn, can boost commodity prices, increase foreign investment demand and, by extension, corporate profits and stock prices.
There's no doubt that Americans will spend more money when they feel better about their stock and home values. And spending leads to hiring.
And all of this would sound perfectly great if not for one little thing: inflation.
Inflation is classically defined as too much money chasing too few goods. Right now, it's easy to see that, while there may be plenty of cash in savings accounts, corporate coffers and bank balance sheets, cash isn't chasing much.
Home prices are still falling, restaurants and retailers have lowered prices and there's only tepid demand from the consumer.
This is a direct result of de-leveraging. Prices (and credit) were out of whack, and now, prices are returning to a level where consumers see value. (I might point out that employment was also out of whack, as the housing bubble created an amount of jobs that were unsustainable, too.)
Of course, we are seeing prices rise, largely due to the rally for oil prices. That affects prices at the pump as well as goods that require transportation, like food. And the net result is added strain on already tight household budgets.
To me, that's the Fed's dilemma in a nutshell. And the Fed is clearly hoping that it can spark some asset inflation that will outpace the trickle down effect of commodity inflation.
No doubt, the Fed is engaging in a delicate balancing act. And there's no guarantee of success.
Right now, inflation is mostly imaginary. That is, we can imagine that current monetary policy will create inflation at some point in the future. And we can imagine that any such inflation could be very bad. Because how do you fight inflation should economic growth remain weak?
That's the dreaded "stag-flation", and nobody wants to see that, much less fight it.
The Fed's primary measure of inflation is wage inflation. When wages start rising quickly, it's a sign that the economy is overheating.
I think we can all agree that we're not in danger of seeing wage inflation anytime soon. But that doesn't mean there won't be pockets of instability springing up as a result of Fed policy.
I will stay diligent, and continue to bring you my best ideas and observations about stocks and the economy.
There's only a little time left before the Fed makes its announcement about more quantitative easing. And whatever the Fed says, there will certainly be some excellent trading gains to be had.
Jason Cimpl, the short-term trading expert at Wyatt Investment Research, has his TradeMaster Daily Stock Alerts subscribers ready to capture some of those gains.
In his recent Special Opportunity Report, Jason has mapped out two strategies to take advantage of the stock markets' reaction to the Fed.
If you'd like to score some short term, double-digit gains, you can learn about Jason's Special Opportunity Report HERE.
As always, I want to hear your thoughts. I'll even print them. Write me here: dailyprofit@wyattresearch.com
