Three Key Issues At Work Looking Forward

More chatter about the Fed enacting QE3 stimulus at the September FOMC meeting. If this isn’t already priced into the market… how much more can it really impact the markets short term? Isn’t this really all about the economic picture? Yes, it is about the economy, but the Fed is seen as the driver of the economy good or bad currently. Remember, there doesn’t have to be any truth to what investors believe only a willingness to commit money in that direction. Thus, we are looking for the upside to maintain its current course as long as the Fed is accommodating relative to stimulus.

With that in mind, there are three key issues at work going forward. First, the bull market or uptrend remains intact. The June 4th low remains the current pivot point of the trend and a break through the 1430 level on the S&P 500 index is the goal short term. A break below 1390 would put some pressure on the current trend, but it would not put an end to the move. It is hard to put the trend in perspective when you are listening to the economic data and pundits talking about the current values not being warranted and a correction is coming soon. It all sounds logical relative to what we know to be true, but the sentiment is to the upside short term. However, a pullback is part of the trend as long as the key support levels hold. A break below 1365 would get my attention on the downside and break the current trend off the June lows. Thus, watch any short term selling as an opportunity unless the trend breaks. Set your stops accordingly and keep looking forward as markets trade relative to what is ahead not what has happened.

Second, money will migrate to stocks from bonds to stocks. In fact, we are already seeing this happening. If the trend continues and the threat of inflation (discussed below) grows as a concern, interest rates will rise sending investors to other opportunities. Thus, the in flow of money into stocks will come from the fixed income or bond assets. The influx of money from foreign investors will continue to grow as well. The lack of growth in Europe will continue to see money rotate to where it is treated the best. Countries like Spain will continue to see money leave to areas of perceived safety versus a negative outcome relative to debt or default on sovereign debt. China is another country that is shifting on outflows from  stocks to other countries. Stocks indexes may see a mild correction or pullback short term, but the inflow of new capital will fuel the upside for stocks.

Third, all of the stimulus being provided by the Federal Reserve will eventually come with a price… inflation. The liquidity provided to the markets has to go somewhere and that is stocks, however the side effect of this “free money” is inflation. The impact or growth of inflation will not happen immediately, but at some point we will pay the price for the liquidity provided in terms of higher prices. The other form of inflation that will be more immediate is in commodities. Food and energy are both moving higher currently and will act as a tax on the consumer. This is one area that could negate the uptrend in play if the climb in prices are too fast.

What are the opportunities for you and I as investors? Watch the major indexes to clear resistance at the current highs. The S&P 500 index as discussed above needs to clear 1430 and continue higher. The NASDAQ index is 3135 and the Dow Jones Industrial Average is 13.330. Each of these indexes can be played using ETFs. SPY = S&P 500 index, QQQ = NASDAQ 100 index, and DIA = Dow Jones Industrial Average. In addition there will be leaders from the major sectors as the indexes advance. Thus, watch the updates here for more on which leaders to own as the break higher is experienced.

Short opportunities in the countries where money is leaving. An example of late has been China (FXI). The downtrend in play is sitting on key support levels and a break would only add to the upside of FXP, ProShares Ultra Short China ETF. The same can be said for bonds as money rotates from the fixed income side to equities. TBF, ProShares Short 20+ Year Treasury Bond. As money moves there are two ways to play the migration. First, own where the money is going, and second, short where the money is leaving. Either way there will be opportunities.

Benefiting from the inflation generated by the stimulus is a matter of owning stocks that benefit and TIP bonds. Look for assets that do well during inflationary periods. The move higher in inflation is likely to be the mild version of 2-5%, and not the 1970’s type of 13-18%. There will be opportunities created by the shift in the economic data.

There are plenty of things to be worried about, but you have to have a belief of what you perceive will happen, and then let the markets and data disprove or validate those beliefs over time. You will have to make adjustments as time moves forward and the data offers validation of what is working and what is not.