News Analysis date published New: 
Monday, September 24, 2012 - 08:30
New Date created: 
Monday, September 24, 2012 - 08:30
New Date last updated: 
Monday, September 24, 2012 - 08:30

How to Profit from Bernanke's Risky Plan

Monday, September 24, 2012 8:30 AM

The recent decision by Federal Reserve Chairman Ben Bernanke to artificially inflate the economy to the tune of $40 billion dollars a month has the markets screaming higher. The big talk on the Street is that most money managers and individual investors have missed the run-up and will be forced to dive in head-first to make up for lost ground. What no one is telling investors is that if QE3 (the third round of so-called "quantitative easing") is not like the two prior versions, and that patient investors will have the opportunity to start late and finish ahead.

A quick review of QE1 and QE2 illustrates that there will be a buying opportunity... and relatively soon.

The QE1 trade
When QE1 was first announced on Nov. 24, 2008, the Dow Jones Industrial Average rallied nearly 400 points, ending the day at 8,443. The honeymoon lasted for 33 trading days, at which point the index started a death spiral, ultimately to a close of 6,547 on March 9, 2009: A staggering 23% decline.

This is not the part of QE that is getting reported right now. Instead, what usually makes it into the headlines is the fact that the market returned a hefty 28.5% from start to finish during QE1, not to mention the fact that the Dow is up nearly 60% in total since then.

But even after reaching its bottom, the Dow hit other rough patches during QE1, allowing investors who weren't on board when it was first announced to get a piece of the action. Before QE1 ended in March 2010, two buying opportunities presented themselves in the form of 7% corrections.

The first opportunity took place between June and July of 2009. The Dow peaked at 8,799 on June 12, but reversed course within a matter of weeks and dropped to 8,146 -- a 7.5% pullback -- well below the index's value at the start of QE. The second opportunity took place six months later as a Jan. 19, 2010, high of 10,725 went south to 9,908 within three short weeks, marking another painfully quick 7.6% pullback.

But as QE2 also illustrates, you don't have to be the first one out of the gate to earn some healthy profits.

The QE2 trade
QE2 wasn't exactly a fairy tale, either.

It started on a dip and, while the Dow traded up for the first couple days after it was announced on Nov. 3, 2010, eclipsing 11,440, it took a quick 400 point retreat (3.8%) during the next eight trading days. This offered investors a "get out of jail and back into the markets" ticket. The market responded well after that dip, climbing to a high of 12,391 by Feb. 18, 2010 (a 12.5% increase.) It was from that point that slow-moving investors found another opportunity as the market traded down through March 18, 2010, ultimately bottoming at 11,613 -- a 6.2% decrease and a mere 200 points away from where QE2 started. From there, QE2 finished strong, ending its run on June 30, 2010 with an aggregate 12.6% gain -- an attractive number, but far short of the results of QE1.

Action to take --> Due to the diminishing return of QE2, as well as the subsequent Operation Twist, investors now need to realize that QE3 may not hold as much upside as previous stimulus moves. However, there should be at least one opportunity, if not two, to get in on the action.

The history of previous QEs suggests a 3-7% pullback is in the cards. Whether that happens in the first few weeks or a couple of months from now, looming issues such as the "fiscal cliff," the U.S. credit rating and the presidential elections are likely to create entry points for slower-moving, more conservative investors looking to profit from this round of stimulus.

Consider establishing initial positions when the Dow nears 13,100 and then again at 12,900. Look for 12,600 as the bottom and point to fill your equity positions.

Robert Lara does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.