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

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

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

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
, 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

As always, I want to hear your thoughts. I’ll even
print them. Write me here: [email protected]

To top