This Is A Speculation-Fueled Market. Here’s Why…

Stock prices began to fall last Wednesday. The catalyst for the move was a familiar one. Selling accelerated late in the day as Federal Reserve Chairman Jerome Powell held a press conference — and I’ve been warning of the risk of Powell press conferences since last August.

I know Powell is aware of the fact that stocks often dive as he speaks, and he does choose his words carefully. This time, Powell was clear. He noted that the Fed will keep interest rates near zero through at least 2022. And it will boost its various bond-buying programs to levels that were unimaginable a few months ago.

The Chairman’s exact words were: “We’re not even thinking about thinking about raising rates.”

After ensuring traders understood what to expect from the Fed, Powell noted that the Fed is worried about unemployment. Here, the news is not good.

“Clearly, not everyone will go back [to work]. But — and I — I would say many will go back, but what’s — what’s going to be the remainder, you know, when we reach sort of what is the new normal? It’s — it’s so uncertain, but it — it could be a good number of millions of people, I think in many — in many estimates.”

Powell concluded his conference leaving no doubt the Fed will focus on the economy and not the stock market:

“I would say that we’re tightly focused on our real economy goals. And — and again, not — we’re not — we’re not focused on moving asset prices in a particular direction at all. It’s just, we want markets to be working and I think partly as a result of what we’ve done, they are working and — you know, we hope that continues.”

What This Means For Us

This is all consistent with other economic forecasts that generally see unemployment remaining above 10% into next year. Although, as we learned earlier this month, the government is having trouble measuring unemployment.

Last week, I noted that stocks rallied after an erroneous unemployment report. The chart of the S&P 500 below that report was the beginning of an unusual pattern. It’s called an “island reversal,” widely believed to be a top.

I believe the island top in this case shows prices are being driven by emotions rather than data.

Speculators Run Amok

Speculation is pushing prices up, and news from Hertz shows exactly how speculative the market is. (I commented on the situation earlier this month, and my colleague Jimmy Butts weighed in this week.)

For those who weren’t aware, the car rental company is in bankruptcy. Last week, lawyers for the debtors asked a judge to allow them sell shares of treasury stock. These are shares that the company is authorized to sell into the market but are held on the company’s book. Often, they end up on the books after a buyback before the Board of Directors officially retires the shares.

CNBC reported that, “The potential sale is highly unusual for a company going through Chapter 11 bankruptcy proceedings since common shareholders, who are last in line when assets are allocated during court proceedings, may be left with worthless stock.

Hertz said it is a last ditch effort for the company to cash in on its volatile stock price as it fights with the New York Stock Exchange to not be delisted.”

In other words, the shares are almost certain to be worthless. But as long as investors are willing to gamble, Hertz would like to sell shares to traders who don’t have concerns about the bankruptcy.

CNBC’s Jim Cramer questioned the plans in a colorful way…

“The question is did P.T. Barnum become the CEO? No, it’s someone else. How do you like that? Maybe they ought to bring in P.T. Barnum because that’s exactly what it takes to have the guts to be able to do that offering. I mean there’s a possibility that it’s worth nothing.”

Cramer said the company’s bondholders will be the first in line to get a piece of the post-bankruptcy Hertz. Owners of the common stock, on the other hand, “are at the bottom of the bankruptcy pecking order.”

I won’t opine on the ethics of this action, but I will note this shows how speculative the market is. Given the lack of concern about fundamentals and the lack of understanding of how bankruptcy works, prices could melt up before completely melting down.

Action To Take

In the long run, we will see lower prices. In the short run, I am watching closely and trading as the market dictates. This means now is an ideal to selectively add calls and puts to your portfolio.

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