Investor Fear Disappears with Liquidity Rally

FOMC free money program stimulates the markets again. The Dow Jones Industrial Average gained more than 2% yesterday to push above the April high.

The economy on the other hand is still trudging along.  The assumed purpose behind quantitative easing is to lower rates and stimulate lending, which in turn stimulates the economy. The challenge, the economy is growing at a 2% clip. This isn't exactly record breaking growth relative to the stimulus provided over the last two years. Quantitative easing part 1 pushed more than two trillion dollars of liquidity into the system and prompted a run in the S&P 500 of nearly 70% off the March 2009 lows. Since the announcement QE2 the S&P has move up more than 14%. Without getting into the economy, you can look at the unemployment rate, GDP, earnings growth and other key data points and deduce the impact.

The whole idea of liquidity is speed of money moving. It is put into the system because the lending structure is such that a bank can lend the same dollar multiple times based on reserve requirements and multiply the impact to the economy (my simplified terms). When the lending isn't taking place, such as now, money finds the next best home, equity markets. Thus, we are now seeing the liquidity rally part 2, thanks to QE2. My comments are not a complaint, it is just important to understand the risk of the system in which are exposing our money. Investor fear is easing and the push of money from the sideline into the markets in conjunction with the liquidity from the Fed is increasing. Thus, risk is rising. There are signs of investors chasing that last 4-10% run to the upside before the selling hits. Every rally has an end or at least a test of the move higher. Take what is prudent and don't get greedy.

Technically, the charts had been showing signs of topping patterns. But, with the FOMC announcement, and a 2% jump in indexes, the broad markets broke through resistance and the upside opportunity resumes. How much? Good question, how much will $900 billion buy over the next 8 months? The VIX index fell 5% yesterday validating less fear and mover greed stepping into the markets. The index is now pushing towards the lows in April where the last top occurred in the broad markets. These are warning signs, not sell signs. How high the market can move on emotions is anyone's guess, remember record losses have been incurred betting against upside momentum.

The Fed is attempting to push everyone into the water with free money and as an investors my greatest concern is the rising risk of swimming in the pool. The dollar was shredded again yesterday as the dollar index pushed lower to the next level of support at 75.60 and is well on its way to the November 2009 low of 74.30. The equity rally from QE2 has come at the price of a 10% decline in the dollar. The ripple effect has been felt in commodity prices where oil has risen more than 20%. Inflation, oops, I mean high prices, are the other side of this market euphoria. You will need to make these kind of returns to keep pace with the cost of goods.

Exxon-Mobil has gained nearly 19% over the last eight weeks, gasoline has increased 21% at the same time. But, the news says no inflation currently showing in the data! Of course that is the same data that said spending $789 billion on stimulus would result in job growth! The liquidity rally part 2 is in play, take what it gives, but take the precautions necessary to protect your assets.

Disclosure Statement: Jim Farrish is the Founder and Editor of SectorExchange.com and TheETFexchange.com as well as the CEO of Money Strategies, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. Investors who are interested in money management services may visit the Money Strategies, I