Will the Fed’s Planned Bond Move Sway the Markets?

The stock market saw another record-setting run last week, but the big news came after Friday’s close.

The stock market put on another record setting show past week, with the Dow Jones Industrial Average (NYSEARCA:DIA) closing at a record high of 15,118 and the S&P 500 (NYSEARCA:SPY) closing at 1633.70, another all-time closing high. For the week, the Dow gained 1 percent, the S&P 500 climbed 1.2 percent, the Nasdaq Composite (NYSEARCA:QQQ) added 1.7 percent, and the Russell 2000 (NYSEARCA:IWM) jumped 2.2 percent.

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However, as exciting as the week’s stock market action was, the big news came after the close on Friday when The Wall Street Journal reporter Jon Hilsenrath published an article detailing a new Federal Reserve strategy for unwinding its $85 billion/month in bond buying known as QE3.

This is big news, of course, because recent stock market action has been labeled “The Bernanke Rally” or “The Bernanke Put” as investors count on the Federal Reserve to support stock market prices and protect them from potential declines.

On My ETF Radar

chart courtesy of StockCharts.com

In the chart above, we see how the S&P 500 has begun tracking a near parabolic ascent that began in January. The S&P 500 is now 11 percent above its 200-day moving average, the greatest divergence seen since March 2000, just before the beginning of the dot-com crash. Will history repeat or only rhyme and in Yogi Berra’s famous words, are you ready for “déjà vu all over again?”

ETF News You Can Really Use

Based on the after-market Journal article, it seems that the Fed is planning to take away the “punch bowl” of easy money. However, the timing and scope of the program is yet unknown. As we all know, markets don’t like uncertainty, and this development, coming along with a steady stream of economic reports indicating a slowing global economy, is potentially significant.

The Fed finds itself in a tricky place as timing the exit will likely be difficult, at best. Leaving it in place too long could continue to stoke asset bubbles, while too quick an exit could lead to significant stock market declines along with volatility in bond and commodity markets.

Here’s a quick summary of recent events:

1.  Stock market levitating to record highs on a daily basis.

2.  Macro economy slowing around the world with a steady stream of declining economic reports.

3.  Near record-margin debt — the highest level seen since 2007 — just before the last market highs and subsequent meltdown associated with the 2007-2008 financial crisis. Margin debt is now north of $350 billion for March and is thought to have possibly reached record highs in April, and this is typically a bearish indicator as excessive risk taking tends to mark market tops. Also, should a sell-off begin, margin calls tend to accelerate the decline as investors have to close positions and so selling can rapidly accelerate under these conditions.

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4. Technical indicators put major stock markets in highly overbought conditions and so vulnerable to decline. The stock market is exhibiting signs of a “blow off top” and Friday’s news from the Fed further add to the risk of a quick reversal.

Last week saw a “another day, another record” as stock markets around the world responded to stimulus action by central banks in Japan, Europe, and the United States.

In economic reports, the weekly new unemployment claims report on Thursday beat expectations and March job openings were flat from the previous report.

This week brings a wave of fresh economic reports:

Monday: April retail sales, March business inventories

Tuesday: NFIB Small Business Index

Wednesday: Producer price index, Empire State Index, Home builders index, industrial production

Thursday: weekly unemployment claims, consumer price index, housing starts, Philadelphia Fed report

Friday: consumer sentiment, leading economic indicators

Bottom line: With new records, a levitating stock market and news from the Federal Reserve, investors will register their reactions on Monday.

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John Nyaradi is the author of The ETF Investing Premium Newsletter.

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