How to profit from the market’s change of heart toward tapering

Back in May, just the whisper of a hint from the Fed that it might consider tapering its $85.0-billion-per-month bond buying program was enough to stop the bull market in its tracks. It recovered, of course, but only after Bernanke soothed the markets by saying he had no intention of pulling back on the Fed’s quantitative easing (QE) policy anytime soon.

The general fear, of course, was that any reduction in QE would translate into an immediate rise in interest rates. Having kept interest rates artificially low (near zero), the Fed made it cheaper for people to borrow. As a result, these artificially low interest rates are generally recognized as being the fuel that’s been propelling the stock market increasingly higher.

The Federal Reserve quashed those fears last week after announcing a $10.0-billion monthly cut in its QE strategy by telling investors it wouldn’t raise interest rates until unemployment hits 6.5%. By the Fed’s own estimates, the country will not hit this target until late 2014 to mid-2015. So, artificially low interest rates live on.

The assurance of cheap money kept the markets upbeat; so much so that the following day, theDow Jones Industrial Average and S&P 500 opened at record highs, and the NASDAQ opened at a 13-year high.

News on a few key economic indicators released last Thursday, the day after the Federal Reserve’s announcement, probably didn’t hurt either, as these indicators suggested the economy isn’t doing as well as some had thought.

November existing-home sales in the U.S. housing market dropped (4.3%) for the third consecutive month to an annual rate of 4.9 million—the weakest pace since last December and the first time since April that the U.S. existing housing market pace has dipped below 5.0 million. (Source: “Existing-Home Sales Decline in November, but Strong Price Gains Continue,” National Association of Realtors web site, December 19, 2013.)

The eternally optimistic National Association of Realtors still thinks total housing market sales this year will be 5.1 million—the strongest level since 2007 (just before the housing market bubble popped), but below the 5.5 million sales threshold that’s associated with a healthy housing market.

But that housing market target won’t be hit because of eager young first-time homebuyers. This demographic accounted for just 28% of sales in the November housing market, down from 30% a year ago. In a healthy housing market, first-time homebuyers make up at least 40% of all buyers. The financially well-heeled seem to be taking it all in stride. All-cash buyers accounted for 32% of purchases—up from 30% last year. Investors made up 19%.

A renaissance in the U.S. housing market is contingent upon a strengthening jobs market, which would buoy consumer confidence levels. That exuberance may have to wait a little while; shortly before announcing weak existing-home sales, investors were told that first-time claims for U.S. unemployment benefits rose for the second consecutive week, hitting a nine-month high… Happy holidays!

Initial jobless claims climbed to 379,000 for the week ended December 14 from a previous 369,000 and the forecasted 336,000. This time last year, when the economy was much worse (according to most mainstream analysts), claims totaled 366,000. (Source: “Unemployment Insurance Weekly Claims Report,” United States Department of Labor web site, December 19, 2013.)

Negative economic indicators, such as weak declining U.S. housing market sales, strong housing market price gains, and high unemployment claims numbers bode well for keeping interest rates artificially low.

With cheap easy money fuelling the stock market, investors might want to consider an exchange-traded fund (ETF) that tracks the broader S&P 500 index, like the SPDR S&P 500 ETF Trust (NYSEArca/SPY); it’s up 32% year-to-date and 118% since 2009.