The Fed Has Spoken — Now What?

by Sam Collins | September 14, 2012 2:47 am

Investors got more than they anticipated from the Fed Thursday with the announcement of a QE3-Plus. Blue chips led a rally that also was focused on materials, energy and precious metals as buyers chased stocks that could be impacted by inflation. The Dow Jones Industrial Average reached its highest level since December 2007, the S&P 500 its highest level since November 2008, and the Nasdaq its highest level since November 2000.

The-much anticipated Fed plan focused on the central bank’s buying of $40 billion of mortgage-backed securities a month. Fed Chairman Ben Bernanke said that “Operation Twist” will also be extended and that interest rates should remain near zero until at least mid-2015 — a one-year extension of the Fed’s prior target date. He went on to say that the principal reason for more stimulus was job creation.

At the close, the Dow had vaulted to 13,540, up 207 points, the S&P 500 gained 23 points at 1,460, and the Nasdaq jumped 42 points at 3,156. Volume on the NYSE totaled 800 million shares and the Nasdaq traded 465 million. Advancers led decliners on the Big Board by almost 4-to-1 and on the Nasdaq by 2.6-to-1. But more importantly, up volume exceeded down volume by 10.4-to-1 on the NYSE, but by just 3.2-to-1 on the Nasdaq.

Dow Chart
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Trade of the Day Chart Key

Thursday’s monster breakout was primarily focused on the blue chips and other higher-quality stocks. Therefore, the Dow Jones Industrial Average was a prime beneficiary of the Fed’s third round of quantitative easing. Its all-time high was made in October 2007 at 14,280, and that is its next target.

NYSE Chart
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The NYSE Composite Index consists of all shares traded on the Big Board. Its composition is much more general than the Dow industrials and is a cross-section of U.S. stocks. Thus, although the NYSE had a good day and broke from a 12-month triangle, it did not post a new high. To do that it would have to pop through the high of 8,718 made in May 2011.

Nasdaq Chart
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The Nasdaq broke to a new high, as well, but the all-time high was made in March 2000 at 5,133 — a long way back to the tech bubble that ended with the new century. Its performance has lagged the blue chips and probably will continue to do so since there are multiple layers of resistance spaced over almost 2,000 points and institutional interest is now focused on higher-quality, dividend-paying stocks.

Conclusion: After months of struggling with overhead that has frustrated traders and investors alike, stock indices broke to new highs confirming that all three major trends (short-, intermediate- and long-term) are bullish. With lower earnings projected for Q4 from fundamental analysts, and technicians, like yours truly, harping on the stubborn overhead barriers of the major indices, especially in the near to intermediate term, how do we explain Thursday’s breakout?

It’s really very simple: A force outside of the normal market supply/demand structure, the Fed, announced that it would inject $40 billion of new capital into the market every month for an indefinite period. On Wednesday, I said, “Traders have already anticipated that on Thursday the Fed will announce a new stimulus plan — but it had better be strong since much of the market’s recent gains have taken, or discounted, a Q3-type of plan.”

The new plan is not only very strong, but unprecedented, and much more than even the most optimistic projections. Bernanke has thrown everything into the struggle and candidly admitted Thursday that the only tools that remain for him to use are “the balance sheet and talking up the market.” Textbooks call the latter “moral suasion.” (It has also been called lots of unprintable names.) This move by the Fed is a “good news/bad news” strategy that recognizes that the economy is in much worse shape than previously admitted.

Buyers’ response, which came mainly from institutions, focused on blue-chip stocks — an indication that the risk of being wrong could be high. I agree, and therefore wouldn’t chase stocks that are making new highs. The Fed’s plans will be thoroughly dissected in the coming week and most likely will lead to a pullback and better buying opportunity — perhaps not a 5% to 10% correction, but more likely a round of normal profit-taking that will run out of steam after much of Thursday’s advance is retraced.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[1].

For a list of this week’s economic reports due out, click here[2].

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