Can QE Bail Out the Stock Market Once Again?

Stocks faltered during QE1 and recovered. Stocks also tumbled during QE2 and rallied back to new recovery highs. From its September high the S&P 500 has already lost 100 points, will QE3 bail out the stock market again?

QE3 looks like the Fed’s biggest boomerang yet. Bernanke announced QE3 on September 13. The S&P closed at 1,460 on this faithful day and recorded a new multi-year recovery high the very next day (1,474.51). Since then the S&P 500 is down 6%, the Nasdaq-100 nearly 10%, and Apple about 23%.

Can QE3 bail out stocks once again?

Based on the QE track record the answer is a plain and simple: Yes.

However, this may not be the time to take a plain vanilla approach. QE3 is the same animal as QE2, but a different breed and even QE2 had some serious genetic flaws that showed up on stock charts as big gashes.

QE2 vs. QE3 – Same Animal, Different Breed

Back in November 2010, I wrote an article on the correlation between the Fed’s Permanent Open Market Purchases (POMO, also known as QE2) and the S&P 500.

Specific transactions, such as coupon purchases of $3.5 billion or larger (back then the Fed was buying Treasuries), resulted in positive S&P performance 89% of the time (when there were no POMO buys, the S&P was up 58% of the time).

Via QE2 the Federal Reserve bought an average of $75 billion worth of Treasuries a month. Via QE3 the Federal Reserve is buying $40 billion of mortgage-backed securities (MBS) per month.

In Addition, throughout November, the Federal Reserve will purchase $47 billion worth of long-term Treasuries (maturities from 2018 – 2042) and sell $37 billion worth of shorter-term Treasuries (maturities from 2013 – 2015).

The net amount of securities purchased by the Federal Reserve (in November and December) will be $50 billion, compared to about $75 billion during QE2 (I’m not sure if the Fed is still reinvesting maturing Treasuries and if it will extend Operation Twist, scheduled to expire at the end of the year).

QE2 – Not Everything That Shines is Gold

The thought of QE2 triggers images of relentlessly rising stock indexes. Sandwiched in between those “market on steroids” segments, however, were nasty selloffs. One in March 2011 (Japan earthquake) and one in May 2011 (the May 2010 and July 2011 meltdowns happened right after QE1 and QE2 ended).

From the beginning to the end of QE2 the S&P gained only 11%. The chart below shows exactly when the various QE’s started, when they ended, how much stocks gained, and the selloffs in between.

QE doesn’t guarantee higher prices, but thus far in this QE bull market stocks have always been able to recover from any decline and move on to bigger and better highs. Will this be the case again?

Technical Indicators

The S&P 500 and Dow Jones didn’t show any major breadth divergences at their September highs and there are some giant open chart gaps, which suggests that prices will indeed end up recovering some of the recent losses.

So the odds for an eventual year-end rally are good (not sure if it will reach new recovery highs), but we haven’t seen panic selling or bullish price/RSI divergences that would point to any sort of more permanent bottom (we may say a daily price/RSI divergence at today’s close).

At the Profit Radar Report we will simply continue to adjust the stop-loss level for our short positions. This virtually guarantees a profitable trade and exposes us to all the profit potential on the short side. We will take profits once indictors tell us a bottom is near.

The Profit Radar Report monitors money flow, seasonality, sentiment, technicals and other developments to identify low risk and high probability trades and investment opportunities for subscribers.

Romney or Obama – 7 Reasons Why the Next 4 Years Will be Lousy for Stocks Regardless

The U.S. presidential campaign is nearing its end and there are some compelling reasons to actually vote for the presidential candidate you like least.

This Bloomberg headline caught my attention: “Economy set for better times whether Obama or Romney wins.”

The commentary brings out that: “No matter who wins the election tomorrow, the economy is on course to enjoy faster growth in the next four years as the headwinds that have held it back turn into tailwinds.”

From Headwind to Hurricane?

Optimism without realism is just wishful thinking and unfortunately the article lacked any factual evidence pointing to a sustainably strengthening economy.

In fact, there are many reasons why the headwinds created by the 2008 near financial collapse will turn into a hurricane, not tailwinds.

1) Artificial Everything: The human body needs nutrients to function at its optimum. Real and organic foods are the best source of nutrients. The 2004 documentary “Super Size Me” shows the body’s reaction to a junk food only diet.

Like the human body, the economy needs real and organic growth to function at its optimum, but all it’s getting is junk food mixed with steroids. Artificial earnings growth, artificial GDP growth, and artificial jobs creation result in an artificial stock market. The sugar crash is coming.

2) Fiscal Cliff: Financial engineering has become the top U.S. industry sector, but despite the abundance of financial engineering talent, there are only two ways to reduce the U.S. deficit: A) Cut government spending and B) Increase taxes.

Both options are as necessary as they are counter productive to an expanding economy.

3) Baby Boomers: Baby boomers were born between 1946 and 1964. More than 10,000 baby boomers a day will turn 65, a pattern that will continue for the next 19 years. There are 76 million of them and it is estimated that they account for about 50% of total U.S. spending.

4) Low Interest Rates: Retired baby boomers are reliant on interest rates and dividends to generate income. Interest rates are near all-time lows and generating retirement income is nearly impossible.

Imagine a retired couple with a $1,000,000 nest egg. At best you may find a 1-year CD with a return of 1%. That’s $10,000 a year or $833 a month. Not too long ago you could earn $50,000 a year or $4,166 a month. Retirees will be forced to clam up and hold on to their money if the nest egg is to last.

5) Flight to Junk Investments: Low interest rates force investors into higher yielding vehicles. Those include high yield bonds (more appropriately called junk bonds) and municipal bonds. But there’s no free lunch on Wall Street.

If you want higher returns, you have to take more risk. The iShares iBOXX High Yield Corporate Bond ETF (HYG) and the iShares S&P National AMT-Free Municipal Bond ETF (MUB) have been bid up to near all-time highs.

Financial liquidity is as much about money flow as it is about perception. We’ve seen in 2008 how fast perception can change and how fast junk, muni bonds and even investment grade corporate bonds can drop.

6) Deflation: Japan has been dealing with persistent deflation for decades. Money infusions by the Bank of Japan (Japan’s equivalent to the Federal Reserve) failed to resurrect the economy. Deflation suffocates an economy.

The fact that trillions of dollars worth of U.S. QE money hasn’t caused the expected inflationary environment warns how close the U.S. is to the deflationary spiral.

7) Systematic Problems: A ship with a leak in the hull requires a trip to the wharf. Replacing the captain may quiet uneducated passengers, but it doesn’t fix the problem.

The U.S.S. America (our economic ship) suffers from many “leaks.” A new president, regardless of who it is, can’t fix those leaks.

Like water, Wall Street and Washington always travels the path of least resistance. Unfortunately, the path of least resistance leads to a dead end littered with all the cans that have been kicked down the road.

Like water, the stock market finds small cracks and applies pressure until it bursts. The market has found the economic weaknesses; it’s just a matter of time until the wall of “extend and pretend” breaks.

How will Obama’s election affect stocks? Look at the ship, not the captain.
How will Romney’s election affect stocks? Look at the ship, not the captain.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

It’s Do or Die Time for Small and Mid Cap ETFs

Small and mid cap stock indexes are trading at key inflection points. How the indexes and ETFs react to support at current prices will likely set the bias (bullish or bearish) for the coming weeks.

“Do or die” scenarios don’t come around too often, but when they do they deserve our attention and often provide either a low risk or a high probability trading opportunity.

What elevates the current constellation for mid and small cap ETFs from willy nilly to do or die?

There are a number of reasons. The two charts below were originally published in the October 24 Profit Radar Report. The “in a nutshell” conclusion published that day was that: “The stock market is stretched like a rubber band and should bounce back. If it doesn’t, it will ‘snap’”.

Chart 1: S&P MidCap 400 Index

Corresponding ETF: SPDR S&P MidCap 400 ETF (MDY)

The trend line originating at the October 4, 2011 low has provided guidance and support for the S&P MidCap 400 Index. A close below this trend line would be concerning. Additional support is provided by the 200-day SMA at 964.

Chart 2: Russell 2000 Index

Corresponding ETF: iShares Russell 2000 Index ETF (IWM)

The interaction between the Russell 2000 and its October 4, 2011 trend line hasn’t been as pronounced, but the decline has thus far stalled at trend line support. A close below this trend line would also be concerning. Additional support is provided by the 200-day SMA at 807.

Conclusion

Unbroken longer-term trend lines like the ones mentioned above provide invaluable technical insight, often worth more than insider information.

As long as indexes remain above their respective trend lines – the S&P 500, Dow Jones, Russell 2000, MidCap 400 and many sector ETFs remain above at this time – the benefit of the doubt should be given to rising prices.

In addition to trend line support, the October 25 Profit Radar Report pointed out a buy signal for stocks (given by the VIX) and a bullish price/RSI divergence.

Yesterday’s strong rally is running into technical resistance triggered a bearish percentR low risk entry. It remains yet to be seen how long this bounce will last, but trend line support is now our stop-loss level for long positions. The beauty of using a rising trend line as stop-loss for long positions is that it virtually guarantees a winning trade.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.