By Chris Diodato
Bernanke was presented with two choices regarding the fate of the American economy. His decision was clear after yesterday's speech.
Choice #1 - Do nothing
- America slowly slips into mild recession
- Inflation remains a non-issue
- Stock market goes down, unemployment increases
- Obama loses the election (S & P has direct correlation to presidential approval ratings)
Choice #2 -QE3
- Economy stabilizes in short-term
- Inflation spikes
- Gasoline breaks record highs
- Stock market jumps initially
- Obama wins election
- Inflation eventually goes out of control
- We get a large recession
Of course, these are my personal opinions, but I would like to take a brief moment to explain why this QE3 was a much risker move for the welfare of the economy than the previous QE policies.
Bernanke's timing of QE3, using it now, is key to the future of the US economy. In the past, Bernanke activated the printing press only when expected inflation was relatively low. That is why, while the previous QE policies did produce some inflation, inflation never went outside the Fed's target zone. Now, the Fed is deciding to act while expected inflation, which generally leads real inflation, is high. Expected inflation is measured by the difference between inflation protected bonds. Another way of measuring this, as seen below, is to chart the ratio of the TIP ETF (TIP) vs. the 10 year Treasury ETF (IEF).
On a completely textbook technical basis, with zero fundamental facts considered, the ratio is breaking to the upside out of a "triangle" formation. The price target of this breakout puts us in the same zone we saw before the oil panic of 2008.
The result? Bernanke has brushed aside half of the Fed's dual mandate, and inflation is on its way. Inflation, whether caused by government action or international events, is surprisingly typical in late bull markets (think late 2007 into 2008). Sectors that react best to inflation are commodity dependent sectors, such as materials, energy, and mining. Besides that, companies that own large amounts of fixed assets also perform well; most of these companies will fall under the large cap and "mega" cap classifications. That's where to invest now. Look at the technical buy signals in the charts of (XLB), the materials ETF, and (XLE), the energy ETF. Both ETFs give targets 20% higher than their current levels.
Bernanke has pushes the proverbial "big red button," and the market will rally, at least until inflation becomes too much for our economy to manage. Before that point, however, there is still much money to be made, and it is to be made in these sectors.
Disclosure: I am long XLE.