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It is a somewhat risky venture to advocate a sell strategy in equities after the sharp slide in prices last week. It is also somewhat risky to get short the stock market in the face of the chance for movement on QE2. However, the equity market seemed to catch a lot of positive breaks over the last several months, and many rallies seemed to come in close proximity to press coverage suggesting that the GOP was going to deal the Democrats a heavy blow in the November elections. In many cases it is too close to call how some races will pan out, and according to polls the Democrats are set to lose some seats but perhaps not as many as was initially predicted. Furthermore, it appears that the latest corporate earnings cycle may have started out positive, but then a series of disappointments in the tech sector seemed to take the bloom off the flower. While short term technical measures were reaching modestly overbought readings into the October high, the correction last week served to temper that potential negative.
However, it is our opinion that the equity markets are perhaps the guiltiest of buying into the rumor of QE2. While stocks might rise in the wake of the actual implementation, there is a moderate amount of trading time ahead of the Fed’s November 3rd announcement, and we don’t think the Fed will act ahead of the election unless there is an event that threatens to derail sentiment.
QE2 could have a substantially bullish effect on the market, and we wouldn’t want to be short the market into that news. However, the realization that the economy is still fighting pockets of slowing, the fact that the earnings cycle didn’t offer much of a tonic, and with some investors likely to balk ahead of the election, it appears that the bear camp has gained an advantage in the equities markets.
In our opinion, when the stock market was trading its October highs it was actually factoring ideas that the economy was recovering and that QE2 might offer up a growth and earnings surprise in early 2011. We would suggest that traders take a risk-controlled look at a downside move into the election through the purchase of just out of the money, near to expiration puts.
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