The Day Ahead: The Fed Is Like an Old Flame

Heartbreak, to put it mildly, is the pits. Through the years, I have broken down relationship-induced heartbreak into four stages: (1) initial anxiousness that the gaping void in your life will never be filled again (week one); (2) raging anger at the other person for their serious judgment error in dumping you (week two); (3) healing process begins by exterminating all physical evidence of the relationship and hitting the "scene" (week three); and (4) wiping the other person clear from your head, except for certain remembrances that are inevitable along the way (week four and beyond).

As we prepare to conclude the latest earth-shattering finance moment that most people know nothing about or care to understand -- the Federal Reserve meeting and a press conference from Ben Bernanke, the most powerful man on Earth -- one thing is obvious to me. Namely, investors remember the Fed's easing efforts as fondly as they do an old flame five years post-breakup.

Why? To be honest, the first and second rounds of quantitative easing, Operation Twist 1 and Operation Twist 2 have all had profound impacts on mortgage rates and stock prices. That's because they were blunt-force actions. They came in large slugs, or denominations, if you will, meant to address very specific and severe dislocations in the economy -- and in the stock market, though Bernanke won't officially admit that. These dislocations were a byproduct of the fact that the Great Recession was never allowed to heal on its own. (Lob that one up for debate among your Republican friends.)

Your Fed at a Glance

  • November 2008: $600 billion QE plan
  • March 2009: $750 billion QE plan
  • Note: After QE1 ended in March 2010, the S&P 500 was higher by 73% or so vs. March 2009.
  • November 2010: $600 billion QE plan
  • Note: From November 2010 to June 2011, the S&P 500 rose 11%.
  • Operation Twist 1: September 2011
  • Operation Twist 2: June 2012

Fond memories:

  • Boost to stock prices immediately, and then over a longer period
  • Eventually set the stage for the housing market's 2012 recovery
  • Companies are issuing new debt at attractive rates, buying back stock, increasing dividends and improving their capital structure by refinancing.
  • The Fed has shown investors globally the full range of tools at its disposal. Pre-Bernanke, not many had been aware these abilities existed. (You didn't, so stop.)

Surely there have been other granular outcomes of unconventional -- and conventional -- easing, but why be boring? The problem I'm seeing right now is that investors remember the abnormal easing process in the most positive light. However, as with an old flame, when you stumble on Facebook pictures of them with someone new, an examination of the present-day realities is likely to reveal sharp differences from the past. People change -- and, in this example, the market's reaction to a different style of easing may be different as well.

You see, the Fed is unlikely to announce an eye-popping new program this time around. It may be a jawbone job on interest-rate guidance -- even though that has not worked as designed, given that companies delayed capital expenditures decisions due to tax uncertainty. Alternatively, it may be an open-ended, data-dependent monthly dose of bond-buying. Or it may be both. Assuming the "both" option occurs, we are left with this.

  • We'll have the easing the market wanted, but with limited economic benefit. For example, we may see a slight improvement on Bernanke's "grave" characterization of the labor market. The ball will have been kindly passed back to fiscal policymakers.
  • We'll have another wrinkle in potential long-term disappointment, in terms of being able to unwind open-ended bond-buying without uprooting markets. Can you imagine the market's reaction when Bernanke (or his successor) signals an end is in sight to the program?
  • We'll see the Fed lose some credibility as an institution should QE 2.5 do little to promote "maximum employment and price stability." By the way, the Fed is preparing to offer this bond-buying plan into the teeth of rising commodities prices, partly thanks to the prospect of a QE 2.5 announcement concurrent with the Midwest drought.

I think we'll need to play the short term with a touch of caution, only acting after careful consideration of valid bullish arguments. I feel that, with the wrapping-up of this major global government news cycle, with outcomes telegraphed, a market peak is around the corner. It's likely market players will now place greater stock in a possible third-quarter earnings recession and how that might not prevented by QE 2.5 and action from the European Central Bank -- and how it might arrive on our doorsteps before the fiscal cliff technically kicks into gear.

Convo Bites for the Starbucks Line

  • After Intel's (INTC) sales and earnings warning, I don't think the company's product event this week will reawaken the bulls. If anything, it may illuminate challenges for Intel.
  • When I hear strategists say it's okay to buy stocks in "overbought territory," that raises a red flag in my mind.
  • Retail is shifting into a slow period with back-to-school priced in. So, as we head into August retail sales and consumer confidence reports later this week, don't force things when it comes to top names such as American Eagle (AEO), TJX (TJX) and so on.
At the time of publication, Sozzi had no positions in the stocks mentioned, although positions may change at any time.

Brian Sozzi is Chief Equities Analyst for NBG Productions. In this capacity, he is responsible for developing independent financial content and actionable stock recommendations (including ratings and price targets) for an institutional and retail investor base. In addition, Sozzi is the Editor in Chief of the "Decoding Wall St." investor education online platform.