Stocks surged higher on Tuesday ahead of the Wednesday’s all-important decision from the Federal Reserve whether or not to end the QE3 bond purchase stimulus. In the process, the Dow Jones industrial Average gained 1.1% to retake the 17,000 level — completing the V-shaped recovery from the selloff lows set two weeks ago.
Catalysts for the move included ongoing positive earnings results and a bump in the consumer confidence survey to its highest level since October 2007.
The Dow Jones has climbed for seven of the last eight sessions, and is up more than 7% from the sub-16,000 lows set on Oc. 15. The catalyst for all this: Comments from more dovish Federal Reserve officials that continuing market turbulence and resulting economic weakness could result in additional bond purchases from the central bank.
This merely highlights the obvious: This market has grown dependent on the flow of stimulus from the Fed and is ultra-sensitive to any perceived changes in the flow of said stimulus.
That raises the stakes about as high as they can go for Wednesday’s decision to end QE3. The default scenario is that the Fed pulls the plug, but talks up downside risks to the economy as well as a lack of inflationary pressure, as shown below.
That, in turn, would be interpreted as pushing out the timing and pace of the Fed’s short-term interest rate hikes until late 2015 or perhaps into 2016 — more closely aligning the Fed’s policy stance to where the bond market thinks it should be.
A possible, but less likely outcome, would be for the Fed to keep QE3 going at its smaller, diminished monthly purchase rate until its next policy meeting in December. That would have the benefit of leaving the Fed some room for maneuver of economic weakness in Europe and Asia spills over into the United States. It would also coincide with a post-announcement press conference from Fed chairman Janet Yellen, giving her an opportunity to explain the move and soothe markets.
It’s worth remembering that the Fed, cognizant of how much influence it has on the financial markets, seems to almost always find a way to give investors what they want to hear. It’s hard to believe they would break this pattern now, given that stocks have just now recovered from the deepest selloff in years.
In anticipation of a dovish outcome, even if QE3 ends, I’m looking for the U.S. dollar to pull back from its recent high, bolstering beaten down dollar-sensitive areas of the market such as energy and emerging-market stocks. The chart below shows how the iShares MSCI Emerging Markets Index ETF (EEM) is breaking up and out of its two-month downtrend. The November EEM call option positions I recommended to Edge Pro subscribers late last week are already up more than 25%.
Other opportunities include fast-moving biotech/pharma stocks, such as Pacific Biosciences (PACB) which is up more than 8.1% since I recommended it to Edge subscribers on Oct. 23.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.
