By Chris Diodato

Bernanke had two choices yesterday.

Choice #1 - Do nothing

• America slowly slips into mild recession
• Inflation remains a non-issue
• Stock market goes down, unemployment increases
• Obama loses the election (S & P has direct correlation to presidential approval ratings)

Choice #2 -QE3

• Economy stabilizes in short-term
• Inflation spikes
• Gasoline breaks record highs
• Stock market jumps initially
• Obama wins election
• Inflation eventually goes out of control
• We get a large recession

Of course, these are my personal opinions, but I would like to take a brief moment to explain why this QE3 was a much risker move for the welfare of the economy than the previous QE policies.

Bernanke's timing of QE3, using it now, is key to the future of the US economy.  In the past, Bernanke activated the printing press only when expected inflation was relatively low.  That is why, while the previous QE policies did produce some inflation, inflation never went outside the Fed's target zone.  Now, the Fed is deciding to act while expected inflation, which generally leads real inflation, is high.  Expected inflation is measured by the difference between inflation protected bonds.  Another way of measuring this, as seen below, is to chart the ratio of the TIP ETF (TIP) vs. the 10 year Treasury ETF (IEF).

On a completely technical basis, with zero fundamental facts considered, the ratio is breaking to the upside. The price target of this breakout puts us in the same zone we saw before the oil panic of 2008.

The result?  Bernanke has brushed aside half of the Fed's dual mandate, and inflation is on its way.  Inflation, whether caused by government action or international events, is surprisingly typical in late bull markets. Sectors that react best to inflation are commodity dependent sectors, such as materials, energy, and mining.  Besides that, companies that own large amounts of fixed assets also perform well; most of these companies will fall under the large cap and "mega" cap classifications.  That's where to invest now.  Look at the technical buy signals in the charts of (XLB), the materials ETF, and (XLE), the energy ETF.  Both ETFs give targets 20% higher than their current levels.

Bernanke has pushes the proverbial "big red button," and the market will rally, at least until inflation becomes too much for our economy to manage.  Before that point, however, there is still much money to be made, and it is to be made in these sectors.

By Christopher Diodato

Starting today, and continuing into Thursday, Ben Bernanke will be making statements regarding policy and general economic outlook.    Since this will be the last meeting before the election in November, investors are expecting at least some new type of policy.

Before diving into the trade strategy, let's assess the market environment

• World economies are slowing
• The ECB has written a blank check to monetize European debt
• Manufacturing is contracting
• The unemployment report was a miss
• And most importantly; expected inflation is high

I place most importance on the last point, because it carries critical implications for any future actions by the Fed.  Easing policy causes inflation, there is no question about it.  However, when expected inflation is low, the real inflationary impact is diminished.  When it is high, like now, the slightest amount of stimulus can unleash an inflationary frenzy.  Therefore, within the Fed's dual mandate of controlling both inflation and employment, Bernanke must approach new stimulus with extreme caution.

Assume he unleashes the inflationary hounds

Inflation is often the final issue that drives an economy into recession, but during the inflationary period before that recession, stocks continue to advance.  More specifically, energy, materials, and mining stocks advance, while most others move sideways.  So here's the trade, using the energy ETF, (VDE).

It's typical that energy stocks, like those found comprising (VDE), lead the final push in any bull market, with profits driven by commodity inflation.  In technical jargon, a close above $110 would activate a buy signal from a "symmetrical triangle" as well as a breakout from RSI resistance (Bottom indicator.  For more information on the RSI, click here).  For those who would rather trade the SPDR, (XLE), that chart gives a similar bullish conclusion.

Ben Bernanke has one last chance to give the economy a lift before the election.  If he does, stocks will advance, but so will commodities.  Buy an energy ETF to hedge against the inflation, and perhaps a hybrid car.

Happy trading!

By Christopher Diodato

The market is once again in high spirits this morning, with hopes that the Bernanke will once again dump easy money on the American public.  The technicals are suggesting, however, that any rally will be short lived.  Specifically, the S & P 500 is tracing out a reversal pattern called a “head and shoulders top.”

If the S & P 500 can break above the 1420 level, this pattern would be considered “busted,” but a break below 1395 would activate a sell signal with a target of 1370.  Besides the price action, volume (not available on the chart) also shows a perfect reversal personality, with lower volume on each advance and higher volume on each of the declines.  The RSI "sell mode" note is based of a system I created that has given backtested returns of 300% on ten different markets in the past decade.

I’ll be looking forward to the speech at 10, but don’t see it becoming much of a market event.  Some major market pivots occur next Thursday, so we have three choices.

• Bernanke does something drastic, sending markets up today, and reversing down next Thursday (To see potential economic consequences of new QE, click to see our article posted on Seeking Alpha!)
• Bernanke does something, but the market doesn’t care, so the market begins a new trend next Thursday
• Bernanke does nothing, making markets drop, and reversing back up on Thursday

Happy trading!

~Chris Diodato

By Christopher Diodato

You can hear the same question across most media outlets.  What recovery?  Most world markets made their final top in August of 2011, right when the US had its credit rating downgraded.  Since then, America has been the only major index to continue to make new highs.  This could lead one to think that the recovery has reached a point of stagnation.

However, it gets worse.  The Shanghai Composite index looks like it never even had a recovery.  Here’s the chart.

Note the target of 1018 in the long term.  What’s the adage?  A mania always ends below the starting point?

So, why place importance on the Shanghai Composite?  China is an emerging market, and investing there is still a high risk/high reward situation.  The China 25 index is what some would call the “government monopoly index,” while the composite contains other, smaller, companies, and is therefore more representative of the health of the Chinese economy.

Essentially, it’s the riskiest index of a risky country, and therefore, it usually leads both market tops and bottoms.  So, when a sell signal is issued in this index, as it was when it broke 2100 last night, expect the rest of the market to follow through soon.

Happy trading!