In relatively clear terms — especially compared to former Chairman Alan Greenspan, master of the indecipherable comment — Federal Reserve Chairman Ben Bernanke told the world in the first ever press conference held by the Fed the following:
- Inflation is not an issue. If it is, it is short term and commodity based, not core inflation. I agree.
- Quantitative easing is ending but quantitative tightening is not happening. Translation — the Fed may be ending an expansive program of buying government bonds but when they expire, they will replace them. That means new bonds, so the fed won’t be shrinking its balance sheet and reducing liquidity. They will not stop replacing them until the economy is on firmer footing.
- Interest rates aren’t going anywhere soon — the Fed is keeping them low. And it will not discuss rate hikes for at least “a couple of meetings.”
What does this mean for traders and options trading investors?
First, the Fed thinks the economy could stall, perhaps even double dip before year-end. Otherwise it would raise rates. Even my cockapoo Sumo knows austerity in Europe is going to lead to a slowdown that could take shape as a recession. Meanwhile, Japan is a wreck, China is slowing down, apparently willfully, and gasoline is now at $4 a gallon. And federal stimulus dollars are just about gone.
If the economy does head south — and I have always believed stagnation or a double dip was in the cards before year-end or in Q1 of next year — corporate profits will disappoint Wall Street. That is not good for the market or individual investors.
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Second, traders love Fed created liquidity — more money to borrow and use to buy stocks and bonds. They have anticipated the end of QE II and no increase in interest rates and that is what they just got. Traders can continue to borrow on the cheap. That is good for the market and for good winning names.
What to do as a trader?
First, assume QE will have some limited impact on markets, the biggest being the end to froth in some individual stocks. Avoid for now and short when they roll over those bubble stocks that truly have been pushed up by quantitative easing. You know, stocks like Open Table (NASDAQ: OPEN) selling at 189 times earnings or Salesforce.com (NYSE: CRM) selling at 290 times earnings.
Second, assume the Street wants liquidity even more than it wants growth in corporate earnings. Remember, this is a traders’ market, not an investors’ market. So the Street will be more willing to reward winners and punish losers. Look for surprising winners benefiting from a more frugal and quality driven consumer — Apple (NASDAQ: AAPL) and Ralph Lauren (NYSE: RL). I would buy Apple (FYI – I own it) and Sell Covered Calls all year long. With RL, play the tendency for the stock to pop on good sales or earnings news in the luxury segment, look at RL July out-of- the-money calls.
Bottom line: a choppy market with an upward bias due to low interest rates. That’s an ideal backdrop to good, old fashioned stock picking.