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Bernanke’s Stimulus Unleashing ‘Liquidity Flood’

The Federal Reserve’s plans to begin buying Treasuries is unleashing a tidal wave of liquidity on the markets that has blindly lifted most asset classes already and will continue to do so for the foreseeable future, traders said. Emerging market equities and commodities may be the biggest beneficiaries.

“The best ‘QE2’ trade is not to abandon the current flood of liquidity into commodities, emerging markets, and technology,” said Joseph Terranova, Chief Market Strategist at Virtus Investment Partners and a ‘Fast Money’ trader. “You can't be a short-term thinker here. It is too easy to want to get out given the gains we’ve already had. Stay with the trade.”

Institutional investors poured money into equities, high yield debt, global debt, municipals and money markets last week, according to Bank of America/Merrill Lynch. The S&P 500 is up 7 percent for 2010 and the iShares MSCI Emerging Markets Index (EEM) is up 13 percent.

“Investors appear to be indiscriminate in what they are buying in anticipation of the upcoming announcement of the Fed’s new asset purchase program, a development that may be exactly what the Fed intended to achieve without even having to print a single dollar yet,” said Bank of America credit strategist Oleg Melentyev, in a note entitled, ‘Liquidity Flood Warning’.

The Fed’s two-day meeting begins tomorrow and the FOMC will release a statement Wednesday afternoon signaling an initial stimulus, economists expect. The initial amount of quantitative easing will be $500 billion, according to the median figure in a CNBC survey of money managers. Many traders expect the Fed to then leave the door very open for further purchases down the road.

“All else being equal, the Fed’s debt monetization will leave more money in the hands of market players to buy other assets, including stocks,” said Charles Biderman, Chief Executive Officer of TrimTabs Investment Research. “If the Fed exchanges more newly printed money for bonds, much of the money is likely to end up in commodities and emerging economies. Investors view commodities as a store of value in a world of massive money printing and deficit spending, and emerging economies are attractive to investors and large corporations because their growth rates are higher, their labor costs are lower, and, in some cases, their infrastructure and equity valuations are more attractive.”

But Biderman raises a key point. Bernanke can open the liquidity dam, but that’s it.

“Obviously the Fed can print as much money as it chooses,” said Biderman. “The problem is that the Fed cannot control where the money goes.”

That has many traders, such as Peter Schiff, President of Euro Pacific Capital, selling Treasuries even though the Fed is going to be a big buyer the rest of the year. Coupon-killing inflation unleashed by this further easing could outweigh the demand created by the Fed as a buyer. Treasuries fell today.

“Sell dollars and Treasuries,” said Schiff. “Buy gold, currencies, commodities, and foreign equities.”

Even though the exact amount and process that may be announced Wednesday is unknown, there is a camp that believes the ‘QE2’ trade is already priced in and over.

“I would be long the dollar since the risk is clearly to the upside given the level of dollar bearishness,” said Stephen Weiss of Short Hills Capital. “In any event, if portfolios still want to position in copper, etc., then the PowerShares Dollar Index Bullish ETF (UUP) is a good hedge.”

But while gaming the post-Fed trade for Wednesday at 2:15 p.m. ET is all the rage on trading floors, it is not exactly the talk of Main Street. A printing press is not exactly the way to get retail investors, who have missed this bull market in equities completely, finally into the market. They still see the layoffs, abandoned homes and penny-pinching going on in their hometowns.

“The Fed may be successful yet again in triggering an asset bubble and kicking the stock market into a liquid sugar-high, but it may have some difficulty getting the wealth-effect on spending it so desires if the general public continues to reduce its exposure to equities,” said David Rosenberg, Chief Economist & Strategist, Gluskin Sheff, in a note. “Even with the very best September since 1939, perhaps Ma and Pa Kettle remember that the secular bull market did not commence for another decade (1949 that is). And that best September since 1939 followed on the heels of the worst August since 2000 and it is this intense volatility that is really turning people off the stock market.”

* For the best market insight, catch 'Fast Money' each night at 5pm ET, and the ‘Halftime Report’ each afternoon at 12:30 ET on CNBC.

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Trader disclosure: On Nov 1, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Terranova owns (APA), (AAPL), (AXP), (C), (GOOG), (GS), (FCX), (IBM), (NOV), (ORCL), (PCP), (PEP), (PFE), (UPL), (VRTS), (XBI); Cortes is short (AAPL); Cortes owns (GOOG); Cortes is short (RSX); Cortes is long S&P 500; Cortes owns (K); Cortes owns (TSN); Cortes is short Euros; Cortes is short crude oil; Cortes is short gold; Cortes owns U.S. Treasuries; Grasso owns (ASTM), (BA), (BAC), (C), (CSCO), (JPM), (LPX), (MO), (MOT), (NDAQ), (PFE), (PRST); Finerman owns (AAPL); Fienrman’s Firm owns (APC); Finerman & Finerman’s Firm owns (BAC); Finerman & Finerman’s Firm owns (JPM); Finerman’s Firm owns (MSFT); Finerman's firm is short (IJR); Finerman's firm is short (MDY); Finerman's firm is short (SPY); Finerman's firm is short (IWM); Finerman’s firm owns S&P 500 puts; Finerman’s firm owns Russell 2000 puts; Weiss owns (UPS); Weiss owns (JWN); Weiss owns (HK); Weiss owns (DVN); Weiss owns (CSX); Weiss owns (COP)


For Joe Terranova
Terranova is chief market strategist of Virtus Investment Partners, LTD.
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