MDM - Model switches to neutral May 31, 2011

Published : May 31 2011 at 17:14 ET

Given the overall action of leading stocks and major averages and that QE2 is still present and likely to manifest in other forms after it ends on June 30, the model has switched to a neutral signal.

Quantitative easing can manifest by the fed reinvesting the proceeds from maturing securities after QE2 ends.

This process could take from 3 to 6 months. Once this process ends, a natural organic shrinkage of the fed's balance sheet would likely take place. All eyes would then be on the stock market to see how it holds up without any quantitative easing.

If the stock market were to start into a correction of some magnitude, the fed would probably find an excuse to launch QE3.

The fed is hoping that the economy will gain traction requiring them to hike rates. Fed futures are pricing in a rate hike in early 2012. But the fed's track record shows they are often late to the game. For example, in the last cycle, they were slow to lower rates, and they will likely be slow to hike rates since Bernanke wants to avoid a depression at all costs. But if inflation gets out of control, it can be very hard to contain. And given the massive monetization of debt that has occurred since early 2009, perhaps the fed should be fearing instead of hoping.

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