Now that the Federal Reserve is well into their bond and mortgage backed security buying spree, they are effectively ensuring that the price does not go down, ensuring a safe and effectively risk free return for the time being.
But when, as they say, will the party be over?
Perhaps risk free is a bit of a misnomer… for those not paying attention, it’s actually a pretty bad turn of phrase.
Remember that the markets are only based on reality in the long term. In the short term, they are based on speculation and predictions. Momentum.
So let’s say, for an example, Google reports earnings that increased (whatever) over this time last year. Sounds great, right? Except that they increased their earnings by (whatever) year over year the quarter before that. Since most of the folks that own Google stock are betting that their growth earnings are going to accelerate, that would be a bit of a nasty shock to finding earnings growth doing exactly the opposite.
Not to say that the fat lady would be singing for Google as a growth story, but enough shareholders are going to take that as a very bad omen, and use it as a signal to sell their stock. This exact scenario played out over at Apple late last year, and their stock took a 40% plunge, as all of the “sure thing” crowd backed out.
Now that the Fed is involved, bonds and mortgage backed securities are the “sure thing”. No one is selling while the Fed is buying up everything it can get its grimy little mitts on.
But what happens when the Fed starts to decelerate their rate of bond buying? It’s probably going to play out in exactly the same way. A lot of folks who is buying (like us) to play the Fed pushing prices unnaturally out of whack are going to start selling as soon as they catch a whiff of waning enthusiasm on behalf of the Federal Reserve.
So when should we sell? The second you hear a whiff of waning enthusiasm yourself. Contrarian investing works when you buy when everyone else has run for the exits, and you’re in for the long haul. Momentum investing, on the other hand, benefits most from an itchy trigger finger. You want to be the first guy to sell, not part of the pack.
So what does that mean in a practical context? How can you be the first guy to sell? Pay attention to the Fed, as always. Know when the meetings are happening. You don’t have to read the minutes or anything too heavy, you just have to read the news surrounding the meeting. If the press are not making a fuss, neither will anyone else. When the shoe drops, you’ll know. Minutes after the meeting. Bond interest rates will jump several percent. That’s your sign, because not everyone reads the news the day of the meeting, and big hedge fund managers can’t unload their entire holdings in one click like you can.
Sometimes, it pays to be the little guy.