Daily Gains Letter

Two Ways to Profit from the Fed’s Loose Lips

By for Daily Gains Letter |


Are investors getting too predictable? When it comes to anything the Federal Reserve says, utters, or even hints at, it certainly seems so. And for astute investors, that’s not such a bad thing.

With the Federal Reserve’s stock market–fuelling $85.0-billion-per-month quantitative easing policy on the line, investors are starting to get nervous.

During the first five months of the year, the S&P 500 climbed a solid 17%; in fact, the S&P hit an all-time intra-day high of 1,687.18 on May 22. Sensing the markets were responding favorably to its divine intervention, the Federal Reserve hinted that same day it might scale back its quantitative easing policy.

Fear that the American economy would have to stand on its own sent the markets reeling and made quick work of the bull market. Over the next four weeks, the S&P 500 lost 6.5% of its value and erased the gains of the previous three months.

Realizing market returns weren’t quite in sync with the American economy, the Federal Reserve qualified its previous statements, saying it might not, in fact, taper off its quantitative easing—and even if it did, that wouldn’t necessarily lead to higher interest rates. Investors cheered, and in July, the S&P 500 rebounded, climbing 6.2%.

On August 2, market exuberance saw the S&P 500 once again hit a new intra-day high (1,709.67). But it was to be short lived: stocks started a multi-day slide on Tuesday, August 6, after a pair of Federal Reserve officials hinted the central bank’s bond-buying program might end sooner than expected.

On Monday, Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said that a move to ease monetary stimulus could come in September, or at any time before the end of the year. (Source: “Fed’s Lockhart Says Reduction in Bond Buys Could Come in September,” The Wall Street Journal, August 6, 2013.)

On Tuesday morning, Charles Evans, president of the Federal Reserve Bank of Chicago, said that depending on economic data, he wouldn’t rule out the central bank easing its asset purchases as early as September. (Source: Gibson, K., “U.S. stocks fall further from recent records,” MarketWatch, August 7, 2013.)

With the Federal Reserve not meeting again to discuss its policies until September 17, investors around the world will be treading anxiously, searching to glean as much information as they can on a possible deadline for the Fed’s data-dependent quantitative easing timeline.

DL_Graph2Chart courtesy of www.StockCharts.com

As is evidenced in the above chart, the S&P 500, after hitting an all-time high, gave up serious ground, dropping below the 50-day moving average, following comments by the Federal Reserve on May 22. After hitting another new all-time high in early August, the S&P 500 once again gave up ground, dipping below the 14-day moving average after two Federal Reserve Bank presidents said quantitative easing could begin in September.

Perhaps not surprisingly, exchange-traded funds (ETFs) that short the S&P 500 have been performing well as of late.

The ProShares Short S&P500 (NYSE/SH) ETF, which seeks a return that corresponds to the inverse (-1x) of the daily performance of the S&P 500, climbed almost seven percent between May 22 and June 24. Over just the last few days, it has climbed 1.5%.

The ProShares UltraPro Short S&P 500 (NYSE/SPXU) seeks a return that corresponds to three-times the inverse (-3x) of the daily performance of the S&P 500. Between May 22 and June 24, it climbed 20.3%, while between August 5 and 7, it returned more than four percent.

No matter what the Federal Reserve says, there are always going to be great buying opportunities.

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