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.

Manufacturing Supports Stock Prices

We’re in the home stretch. Mid-term elections are
tomorrow. And then we get the Fed’s announcement on a new round of
quantitative easing on Wednesday at
2:15
ET
.

If you’ve never watched the market trade ride after
a Fed announcement, it can be spectacularly volatile. And I would expect
this Wednesday’s post-statement trading to be especially volatile. A
100-point swing or two on the Dow Industrials wouldn’t surprise
me.

Against the backdrop of the Fed and the elections, we have improving
economic data and another solid earnings season.

Earnings and the Dollar

Earnings season really gets moving this week as we hear from
heavyweights Bank of America (NYSE:
BAC), IBM
(NYSE:IBM)
Apple (Nasdaq:
AAPL), Goldman
(NYSE:GS), Yahoo (Nasdaq:
YHOO), Johnson & Johnson (NYSE:JNJ), Morgan Stanley (NYSE:MS), Wells Fargo
(NYSE:
WFC), and eBay
(Nasdaq:
EBAY).

Citigroup (NYSE:C) reported this morning, and its earnings
news was similar to JP Morgan’s (NYSE:
JPM): both companies beat expectations by a few
pennies a share, but much of the improvement was due to smaller loan loss
reserves, rather than strong improvement in operations.

Bernanke’s Burden

I don’t want to temp fate. I’m not trying to jinx it. I
understand that stocks (and gold, and oil) are rallying on the Fed’s promise
and the falling dollar.

But this rally just doesn’t want to reverse.

Yesterday was wide open for the bears to take prices lower.
Financial stocks, usually thought of as stock market leaders, were absolutely
crushed. It was a rout. Bank of America (NYSE:BAC) got creamed for 5%. Citi
(NYSE:C) lost 4.5%. Even JP Morgan (NYSE:JPM), after a good earnings report,
was down as much as 4% at its lows of the day.

What’s the Fed’s Number?

Well, new unemployment claims rose by 13,000 to
462,000 last week. I probably don’t have to tell you that unemployment is
moving in the wrong direction.

Of course, we’ve discussed the fact that
unemployment is a lagging indicator and will be among the last data points to
improve until we’re blue in the face. And really, investors seem to be
looking beyond the weekly swings.

What are they looking forward to? Why, quantitative
easing, of course. These days, any weak data makes it seem more certain that
the Fed will dump as much as $500 billion into the system in some form of
asset buying.

A Sales Call to the Government

Technology can fix anything: even the Federal government’s
deficit. At least, that’s what the Technology CEO Council told White House
officials yesterday. The council, headed by IBM (NYSE:IBM) CEO Sam Palmisano
said investments in efficiency technology could save the U.S. government $1
trillion over the next 10 years.

Of course, the meeting was basically just a sales call. And
seeing how much loot the government’s been doling out, I wonder what took
them so long.

Can Bank of America Break $14?

I’m still miffed at Fed Chief Ben Bernanke for not speaking
with confidence about the U.S. economy. For a group to succeed, it must have
confidence that it can succeed.

Generals know this. Coaches know this. But for some reason,
Ben Bernanke just can’t bring himself to give the economy a vote of
confidence.

But perhaps he’s competing with the Bank of Japan and
China’s government in the great race to the bottom for currency
valuations.

The Fed Wants Inflation

Yesterday, the Fed said it was prepared to move on new
stimulus if the economy weakens further. What’s more, the Fed’s statement
that inflation is below levels it wants to see suggests that further easing
is coming. That’s a clear indication that the Fed is still worried about
deflation.

I suppose it’s a good sign that the Fed held off on new
easing action. But the Fed also failed to sound a confident tone about the
economic recovery, which I think is mistake.

Of course, we know the economy isn’t great. But most
economic data has improved over the last month or so. And it should be
understood that there is no magic bullet that puts millions of Americans back
to work. It’s going to take time, re-training and probably some government
incentives.

What the Fed Should Say

Today is Fed day. That’s when we will get the latest policy
announcement and economic outlook from the Federal Open Market Committee
(FOMC). There are 8 of these meetings a year, and the Fed uses these meetings
to decide whether to change interest rates, among other things.

FOMC have been market-moving events for a while now, as the
U.S. economy has struggled.

When the Fed has good news for the markets, its job is easy.
But days like today require some careful comments.