I recently talked about why bears’ concerns over Fed policy or earnings growth aren’t enough to keep me on the sidelines. Now I’d like to examine the main reason why traders – including myself – are eager to put money to work right now.
Investing is much more a function of liquidity and psychology than pure revenue and income data. Right now, there is more money (equity fund inflows) chasing fewer shares (which are being reduced by buybacks and mergers). Economics 101 tells us that more demand + less supply = higher prices.
This equation is not stopping today, tomorrow, next week or three months from now. As long as Ben Bernanke and his protégé Janet Yellen run the Fed, they are going to make sure that markets are amply supplied with money, and companies are going to take that cheap money and buy back their shares, and also buy other companies. This is the Bernanke thesis, experiment and legacy, for better or worse. The U.S. monetary base, created by the Fed, has risen from $800 billion to $3 trillion in the past four and a half years. We know there will be a day of reckoning, but it could be a long time in the future.
The main point is that all that money that’s been created has to go somewhere. With economic activity struggling despite recent improvements, most of the Fed-created money is bound to go into investments and speculation, including most emphatically stocks and real estate. The Fed has purposefully destroyed incentive to own low-risk securities like Treasury bonds by keeping rates low.
This has forced people to buy dividend-paying stocks, as Bernanke believes higher markets will increase confidence, which in turn will create more demand, which will push investments higher, and so on, in a virtuous cycle. Since he has his foot on the gas, and no one has the power or incentive to pull him off, he can be successful for as long as the policy remains in place. Kind of like a check-kiting scheme.
That sounds bad in a way, but there is a silver lining. The stock market tends to lead the economy, rather than the other way around. It’s quite possible that the rise of the market has foreshadowed a big improvement in U.S. corporate growth and consumer net worth. Once higher levels of economic growth are achieved, then the market indexes might consolidate for a long period of time. But even then, there should be considerable sector rotation that will allow us to achieve very solid results.
My systems that I used to determine my stock and options trades for Trader’s Advantage are specifically built to capture the upside from such sector rotation. Right now, the rotation favors super-cap industrials like 3M (NYSE:MMM), staples like McDonald’s (NYSE:MCD) and Femsa (NYSE:FMX) (a recent Trade of the Day), asset managers like Gramercy Capital (NYSE:GKK) (another recent Trade of the Day) and health care like Pfizer (NYSE:PFE) and Celgene (NASDAQ:CELG). Once the winds change, I may be looking at other sectors.
There will be bumps in the road, to be sure. I doubt we’ll get out of 2013, for instance, without at least one 8% intra-year decline. All the more reason to enjoy this uptick it while it lasts.
InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage which aims to capture profits of 15% to 40% and often as much at 100% to 200% in less than 90 days.
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