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How to Profit from Uncertainty: Carpe Diem

By Mark Thomas on December 17, 2012

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Because of the stalemate in Washington, and the self-serving press it’s been receiving, there’s too much negative consensus about the market. As a result, the next few weeks should be a good time to buy and sell in January for a quick profit.

This is not a time to be investing with the herd. Given that we’re in a fairly normal market, where trading ranges dominate and uncertainty reigns, it almost always pays to bet against the consensus. So embrace uncertainty; it’s a good thing.

How do we proceed? Evaluate the current consensus, anticipate the likely outcome, and perhaps most importantly, gauge what investor reaction is likely to be to that outcome.

Fiscal Cliffhanging

The big fear factor now is the “fiscal cliff,” the tax hikes and spending cuts that will occur automatically in January 2013, if Congress fails to arrive at a budget compromise. What’s likely to happen?

Let’s take away emotions, the financial and political pundits, and their analyses from the equation. Then ask: why would politicians who just got re-elected by avoiding the tough decisions and promising the status quo turn around and force austerity on the voters? 

In fact, no significant action on the US budget is likely until there’s a financial market crisis. For now, as long as the Federal Reserve continues to meet our government’s deficit with “quantitative easing,” basically printing money, there is no real pressure to do anything—in fact, there is less.

Matters would be different if the bond market were forcing interest rates higher, foreign investors were pulling out of US Treasuries and liquidity issues were surfacing.

But that’s not the case. The rest of the world continues to have confidence in the US dollar, and our Federal Reserve continues to keep interest rates artificially low.

The fiscal cliff will be avoided. But this is likely to happen through a “band aid” solution: a deal that will delay significant spending decisions for at least six months.

Dip, Not Dive

Our current situation is interesting because investor sentiment isn’t likely to take a major downturn from current levels, something I usually wait for before betting against the crowd. There are simply too many people waiting to buy into a pullback. The big drop in stock prices already occurred in November, when the S&P 500 fell almost 5 percent. Since that low, the market has already gained back 4 percent, and the price chart is starting to look like a “reverse head and shoulders” formation, indicating a temporary dip instead of a downward trend.

So the stock market seems to be moving beyond the fiscal cliff issue, even as the financial media continue to obsess about it.

But in actuality, investor confidence has been shaken and is weaker that the market would have us believe. One major clue? The amount of cash that both individual and institutional investors have on the sidelines is above average.

Confidence—and stock prices—are likely to improve significantly when the fiscal cliffhanger ends. The general market trend has been upward since the lows of March 2009. And this shows no sign of breaking anytime soon, courtesy of the Federal Reserve and other central banks around the world. If you’re a disciplined trader, there are plenty of profits to be made in US equities until the easy money policy ends.

Reality Check

For the first time in perhaps five years, the US economy is better than most investors think. We are finally seeing real growth in spending, construction, employment, retail and even housing, in a broad, seemingly sustainable way.

Adding fuel to this is the Fed. Earlier this month, our nation’s central bank said it would continue buying $85 billion in Treasuries and mortgage-backed securities each month, in an ongoing effort to accelerate economic growth by reducing borrowing costs. This equates to just above $1 trillion in artificially created money annually that will be invested in financial assets because actual lending still remains weak. 

As a result, bond yields have gotten so ridiculously low that there’s virtually no upside to bonds. We now have blue-chip stocks that yield more than their respective 10-year bonds, the first time this has happened in 40 years. When a stock like Intel has a 4.5 percent dividend vs. 2.65 percent on a 10-year Treasury, the capital gains potential in the stock is significant.

Combine the brightening economic backdrop with an overly negative consensus, plus large-cap stocks at very reasonable valuations, and you get the makings of a short-term rally, sometime in the near future.

I’m totally in cash right now, but I’ve found enough good short-term buys to switch to 50 percent to 100 percent invested. And I will begin buying stocks very soon. Of the stocks I follow, these four look especially interesting for a short-term trade (21-day average holding period): Intel (NASDAQ: INTC); Target Corp (NYSE: TGT); Dollar General Corp (NYSE: DG); and United Parcel Service (NYSE: UPS).

What did you think of this article? Please post your feedback below!

Mark Thomas is chief investment strategist of The StreetEdge.com, focused on value-stock trading.

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