In this recent era of QE driven markets, equities rise and fall with every word that Fed Chairman Ben Bernanke says. Wednesday was no different, with the Dow shedding 206 points after Bernanke hinted at tapering of the Fed's bond buying program coming in 2013, and all out ending of the program in 2014. This is based on the FOMC's projections that unemployment will be around 6.5% by May of 2014, and that the economy will grow 3%-3.5% next year. So far, from the data received in 2013, these projections are too optimistic, which will be shown in the coming months as economic data doesn't pan out the way the Fed believes it should.
Currently, the FOMC predicts the unemployment rate to be near 6.5% by May of 2014, down from 7.6% where it stands currently. For this target to be reached in this relatively short period of time, the U.S economy would need to create 228,000 jobs a month consistently from June 2013 to May 2014. So far in 2013, jobs data has not been this robust, as only an average of around 189,000 jobs have been created each month.
To put these numbers in perspective, 2.5 million jobs would have to be created in 2013 to meet the Fed's expectations. This is more jobs created than what has been achieved in the past ten years of economic data. Even back in the housing boom years of 2004-2006, the economy was only creating about 2 million jobs a year, half a million shy of what the Fed thinks we will produce in the immediate future. To expect a sudden 30% uptick in the monthly jobs number for the next eleven months is overly optimistic at best. With no immediate inflation risk, Wednesday's testimony means either Bernanke is disconnected from the real economic picture of the United States, or he is eager to end the program as soon as possible no matter what the jobs picture looks like. If the former, I would expect QE to continue longer than May if jobs data doesn't improve dramatically. If the latter, the markets need to reposition themselves for a slow growing economy without monetary stimulus to improve prices and prosperity or hope for a more dovish chairman upon Bernanke's retirement.
If quantitative easing is to come to a halt in May of 2014, traders and investors need to rethink how they approach the market. Regardless of when the Fed takes the punch bowl away, there are still opportunities for the short, medium and long term that investors can use the recent volatility to capitalize on. In the short term, meaning for the rest of 2013, despite what prevailing opinions are, the homebuilders are still poised to do very well for the rest of the year. As an uptick in interest rates spooked the market, homebuilders were sharply sold off in spite of a brightening picture in the housing market. Specifically, Lennar's (NYSE:LEN) numbers in 2013 have been very positive. When the company reported earnings on March 20, EPS doubled what expectations were on the street and revenues beat by 10.2%. Additionally, Lennar reported their backlog had increased by 82% to 4,922 homes, and the value of the backlog increased to $1.5 billion. This would mean each home that Lennar has in their backlog is valued at $304,754, which is a very important indicator of the future earnings prospects for the company. Overall, the market for homes has swung in Lennar's favor recently and a low mortgage rate from a historical perspective means that the market will continue to bring solid numbers for this homebuilder and all homebuilders in general.
In the medium term, meaning through the end of 2013 and all of 2014, I believe industrials will start to gain momentum as, according to the Fed, unemployment ticks down and manufacturing increases, albeit slowly. In the industrial area, I would choose Cummins (NYSE:CMI) as a play on U.S demand for industrial engines and the increase in natural gas usage. Cummins is a provider of diesel and natural gas engines for the automotive and industrial truck market. Currently, Cummins has many things going for it, but may be subject to short term price swings with imminent and potentially soft economic data. First, Cummins only receives 6% of its revenues from China, which will cushion its EPS amid the current slowdown in the region, which is hurting other industrials more intensely. Additionally, Cummins does 50% of its heavy duty truck sales in the U.S., which should also shield it slightly from volatility in emerging markets. In the short term the stock's price may be beat down by the bears, but I think buyers will be happy they got into the name come 2014 after better economic data lifts earnings and prices higher.
For the long term, meaning for the next three to four years, I think the economy's rate of growth will increase, and the consumer will become more willing to spend on luxury goods and accessories. To play this growth in sentiment and confidence with the consumer's wallet, I'm going with Vera Bradley (NASDAQ:VRA). The company has recently been beaten down because the current CEO announced retirement. The reason for the CEO's exit was his belief that he did not have the expertise to run a company as large as Vera Bradley now is, although he took the company to this size in the first place. This does not raise a red flag as many CEO changes should, because it shows that the company is in a position to grow at a faster pace. If management can find an experienced leader to manage the company going forward, there are many opportunities that could accelerate growth over the long term. One of these opportunities is the online retail space. Since Vera Bradley has a small physical presence in the United States - only 76 stores - the online business is a way to meet more customers in places where stores may not be able to reach. Online sales also require less overhead, which should increase margins. The small physical presence also allows the company to expand over time, and not only in the United States, but in foreign markets as well.
The main point we should take from the Fed meeting is that at some point down the road, now sooner rather than later, easy monetary policy will end and markets will have to stand on their own with no propping up. This means that in order for the market to go higher, economic data must get better, because there is nothing else for investors to fall back on. In the short term, there is going to be a lot of noise about what the economy is going to produce and how markets will react. But in the medium to long term, I believe the economy will continue to grow, which should improve market sentiment and market prices overall.