NEW YORK ( TheStreet) -- Last week, the official recession-dating committee, the National Bureau of Economic Research, announced that the recession was officially over in June of 2009. This was not surprising to most market participants. In fact, the LPL Financial Current Conditions Index reflected at that time a move from contraction to growth. However, the question today that most investors want to see addressed is: Will the economy slip back into recession? On that note, the Federal Reserve's message last week implied the Fed was preparing to take action to help ensure the economy avoids a return to recession. In a surprisingly transparent statement made last week, the Fed told us that inflation is so low it is not doing enough to promote growth. Specifically, the Fed's stated: "Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability." The Fed balances employment and prices by seeking growth that generates the highest level of employment without causing too much price inflation. The Fed has spent much of the past 30 years determining when to attempt to slow down an economy that is growing too rapidly in order to avoid the destructive effects of high inflation. However, when inflation gets too low, as the Fed has noted, it is a sign that growth needs a boost. The Fed typically acts as a counterweight to Congress' inflationary spending impulses. But the Fed has communicated its view that inflation is too low. With Congress unlikely to pass another substantial spending package, the Fed is likely to take action.
Businesses profits weaken straining their ability to pay their debts and leading them to cut production and workers. This, in turn, results in lower demand for goods which leads to even lower prices and so on as a destructive downward spiral takes root.
Commodity-sensitive stocks: The Fed's intention to avoid a return to recession and the potential for another liquidity-fueled rally like that of 2009 argue in favor of stock market performance. On the other hand, the effectiveness of the Fed's actions remains to be seen with liquidity already abundant in the financial system the inflationary consequences seem more assured than better growth prospects. Stocks gained 1% for the week following the Fed's announcement. However, stocks generally slumped shortly after the Fed's announcement on Tuesday. The gains came on Friday as stronger-than-expected data on business spending were released. Not surprisingly, the commodity-driven Materials and Energy sectors outperformed the S&P 500. Emerging Markets: If the dollar weakens, gains in investments denominated in foreign currencies translate into more dollars, boosting possible returns. Emerging Market stocks and bonds benefit from appreciating currencies relative to the dollar and the increasing value of their commodity-based output. High-Yield bonds: High-yield bonds may benefit as yield hungry investors are forced to take on more credit risk to maintain yields. Real estate: Reflation benefits real estate because property prices may rise. But to really boost Real Estate Investment Trust (REIT) performance, reflation must be successful and generate better U.S. economic growth and employment, which is less assured than the inflation consequences. Treasuries: Purchasing Treasuries will be the primary way the Fed implements Operation Reflation. The price of the 10-year Treasury note rallied, pushing down the yield 10 basis points since the announcement by the Fed last week. However, while there may be additional short-term gains for Treasuries, longer-term inflation risks are increasing as well. This risk is evident in the nearly record-breaking spread between 10- and 30-year Treasury bond yields at about 1.2 percentage points. The better economic data reported in September have pushed prices down and the yield up on the 10-year Treasury by 14 basis points this month while the more inflation-sensitive, longer-term 30-year Treasury yields have increased 28 basis points. Direct beneficiaries of reflation are TIPS, or Treasury Inflation-Protected Securities. The principal of TIPS increases with inflation.
Dollar: The Fed's intentions are weighing on the greenback. As the Fed increases the quantity of dollars in the financial system the value of the dollar is likely to fall. The Fed's statement drove the dollar to its lowest level in nearly eight months. The dollar even strengthened against the euro despite news of deteriorating European economic growth and spiking Irish and Portuguese bond yields on rising default concerns.
Even more impressively, the move in the dollar eroded nearly all of the start of a downtrend in the yen versus the dollar that the Bank of Japan took great efforts to create in the week before the Fed meeting. A falling dollar and rising inflation puts pressure on cash as a long-term holding. Financial stocks: Bank stocks may be negatively affected by the Fed's intentions. If five- to 10-year Treasury yields move lower on Fed buying, the profit margin banks earn by borrowing short-term and lending longer-term narrows, crimping profits. On the other hand, investment banks may benefit from the additional credit to fuel profitable merger and acquisition deals and more bond underwriting as businesses look to refinance at lower rates. Nevertheless, since the Fed announcement, financials have been the worst performing sector.