However,  Janet Yellen is known for being dovish so the end for QE may be out of sight and seems unlikely to happen any time soon, in which case the FED will keep its asset purchase program mostly unchanged for quite some time. This will last until unemployment drops to 6.5% and GDP growth accelerates above 3%.

A few days ago, the ECB cut its key interest rate while some ECB officials made comments that ultimately ended up opening the gate for further measures. Their comments led the way for a negative deposit rate and bond purchasing. This international environment pushes the dollar up, something the FED doesn’t really want, a fact that adds more weight to those in favor of continuing monetary easing. This leads one to believe we can expect the current asset buying to stay unchanged.

In such a scenario there is doubt that any major corrections will occur in the stock market. Although the Schiller P/E points to overvaluation, the ratio will continue to rise for some time, while the FED manages downside risks. Eventually it is bound to be corrected, as it was in the case of the 2000 Nasdaq bubble–an issue of concern. Stocks are already up 150% since the bottom hit in 2009, making it time to prepare for a potential crash in order to avoid being caught off-guard. Reduce leverage and add some short positions to counter-balance portfolio risk. Gold and gold-related stocks could also help, especially since the risks of inflation are rising with the massive FED intervention.

For smarter trades subscribe to Tradespoon!

Over the last few years, we have been experiencing a very accommodating monetary policy. This policy has allowed for circumstances that are higher than ever in both the amount spent and elapsed time. The financial crisis of 2007-2009 was so harsh that central banks around the world have taken unconventional measures in order to sort […]

There’s Always an Option  In this current climate with the stock market hitting new highs, bonds underperforming, interest rates near zero, gold and other commodities falling, there is a quest for both yield and safety. The following strategy combines both stock and options and is called the cash secured short put. The purpose is to […]

We can’t forget about the current–and very accommodating–monetary policy that could also be reverted in the near future, potentially dragging corporate profits down. Very low interest rates reduce borrowing costs helping to improve profit margins. As seen above, companies took the opportunity to buyback stock and to inflate EPS, but as soon as interest rates increase again, financial costs will drag profits down.

One last item to take into account is business investment. Companies have not been investing in their business, or replacing old software and hardware. Rather, they have been taking the opportunity to let depreciation decrease, ultimately helping to enlarge their profit margins.

All the above factors point to the need to be careful about the future. The growth in profits we are experiencing seem to have a cyclical nature. Companies aren’t improving capacity, investing in new markets, or creating future growth capabilities, they are just getting as much as they can from the aftermath of the financial crisis and the favorable conditions created by the Federal Reserve. When these transitory factors exhale, the market may crash again. The long term valuation metrics will have to return back to historical averages, just like it did in the past.

For smarter trades subscribe to Tradespoon!

When stock prices rise for too long and lead valuation multiples into uncharted territory, investors typically argue that “this time is different,” coming up with brand new valuation techniques that relate stock prices to very creative corporate variables. This way they attempt to justify maintaining a bullish stance. Back in the late 1980s, Japanese stocks […]

The worst obstacle an investor must overcome is uncertainty. To make an investment decision, an investor needs to look at a company’s past, make some assumptions about the future, and come up with some trigger values that make it worth taking risks. But sometimes the past is confusing, made of inconsistent and volatile earnings and […]

After a surprise move from the Federal Reserve last month, we have come to expect another surprise to happen this week. In our point of view, the FED won’t taper its current bond-purchasing program. Its chairman, Ben Bernanke, is worried about the effects that such a move could have on the economy and government finances. […]