All Eyes on Potential Stimulus Reductions by the Fed
Stocks close higher despite near-term Fed risks. Weaker data suggest tapering changes will be limited. Potential compromises in Syria remove element of uncertainty, supporting stocks and pressuring gold and oil.
Stock markets had something of a surprise outcome last week, as there will be key event risks in coming sessions (market uncertainty is almost never good for stock valuations), and most of the recent economic data has been negative. In most cases, this would lead investors to believe that broader weakness in labor markets and consumer spending would weigh on earnings prospects for companies. This would be a clear negative for stock valuations but this time it is different. Instead, investors have actually taken economic weakness as a positive, because this limits the probability that the Fed will be able to make larger than expected cutbacks in quantitative easing stimulus.
Near-term, this is where most investor attention will be focused. But it is important to remember that the end-of-year fate of the S&P 500 (and stock indexes, in general) will not be solely determined by the Fed and its upcoming meeting. We will still be faced with the next round of Congressional discussions in the US, which will determine whether or not we will see an increase in the debt ceiling. If we remember what happened in markets last time these debates were seen, it is clear that “jitters” and potential stocks (such as credit downgrades) are never good for stock markets, high yielding currencies, or carry trades in general.
The Week Ahead
In any case, the main event next week will the Federal Reserve decision, which will be announced on Wednesday. Currently, the Fed buys $85 billion in Treasuries and mortgage-backed securities each month, and this total figure is expected to be reduced to $75 billion. A “no change” surprise or even a $10 billion reduction (as expected) will likely keep stock markets supported, weigh on the Yen, and send gold prices lower. At this stage, we will probably need to see a surprise reduction of at least $15 in order to pressure stocks, as investors have already accounted for the prospect of a small stimulus decrease.
My Trading Ideas:
1. Trade calls for Monday will be tricky this week, because any major surprises by the Fed could induce volatility and create opportunities to buy certain assets at better prices. For this reason, there is nothing wrong with waiting for the Fed to make its announcement and then buying or selling your chosen asset using a breakout strategy. For the purposes of this article, I am recommending another buy in the USD/JPY at the Monday open, which should come in near important support at 99.10. Aggressive traders can use weekly expiries for this trade, while those with a more conservative stance should opt for end end-of-month expiration.
2. For stock trades, I will be looking to play off of the assumption that reductions in Fed stimulus will lead to downside revisions in forecasts for consumer spending this holiday season. Here, I will focus on Sears Holdings (SHLD) given that the company has missed earnings estimates three straight quarters, has downwardly revised its revenue guidance for 2013, and is trading in close proximity to strong historical resistance levels. Buy monthly PUT options in SHLD at the Monday open, which should come in near 60.80.
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