Federal Reserve meeting fallout? We shall see…
We may be in the middle of earnings season, but this week, traders will be paying much more attention to the Federal Reserve than to any individual company report.
On Tuesday and Wednesday, Ben Bernanke and his cohorts will have their scheduled meeting behind closed doors to try to figure out how best to “shepherd” our troubled economy. The main purpose of this month’s meeting is to try to figure out how best to pare back the $85 billion monthly bond purchase – and, more importantly, how to communicate this strategy to investors.
The Fed needs to cut back (and eventually shut down) this bond buying program. But it needs to let the market down softly, as this program has been very instrumental in propping up the markets. If the Federal Reserve is too direct with its statement, traders could very well pitch a fit – sending stocks sharply lower.
If you’ll forgive a little personal analogy, this meeting closely resembles a discussion I had with my wife about how to tell my daughter that we were NOT letting her go to a Justin Bieber concert last year. Morgan is a little young and way too impressionable to be going to this concert.
Since I was out of town, my wife and I had a text-message conversation and decided to take Morgan out to dinner so we could let her know our decision and explain our reasoning. Unfortunately, Morgan intercepted the text messages before we could speak with her (she’s a little technical wizard) – and pitched a first-class fit when she found out she couldn’t go.
I was told that I would never be forgiven and that I was ruining her life, and I even had to field questions from my little brother (her uncle). Apparently, my sweet little angel had been sending HIM text messages asking, “Why does my Daddy HATE me?”
Sigh. The joys of parenthood…
While Morgan and I eventually made up, (it’s amazing what chocolate cake and ice cream can buy), it took a lot of drama and discussion before things settled out.
Interest Rate Drama at the Federal Reserve
While traders will be hanging on every word of the Federal Reserve announcement (scheduled for release Wednesday afternoon), there’s really no question what the Fed will do. The Federal Reserve must curtail its bond buying program and allow interest rates to float back to more normal levels. It’s just a matter of figuring out when the Federal Reserve will actually reduce its level of monthly purchases.
Traders are already reacting, with interest rates rising and fixed-income prices falling. If we are seeing these dramatic shifts in capital before the Federal Reserve actually implements a change in policy, imagine what will happen once the purchases stop.
As the drama surrounding the Federal Reserve announcement picks up, our opportunities for generating investment income will shift substantially. Last week, we discussed how the Fed’s policy has manipulated the market for dividend stocks. As the Federal Reserve exits the bond market, we should see a dramatic increase in yields for dividend stocks (giving us a chance to buy very attractively priced income plays).
Accelerated Income Strategies
Another area of opportunity that I am seeing is in covered call investments.
If you’ve never set up a covered call trade in your account, you have been missing out on some tremendous opportunities to generate income from your investments.
This strategy involves selling another trader the right to buy your stock at a specified price for a limited time period. For instance, you could own Intel (NASDAQ:INTC), which is currently trading above $23, and sell someone the right to buy the stock from you at $25. (This right is commonly referred to as a “call option.”)
By selling this right, you receive a payment – which is yours to keep regardless of what happens to the stock.
If the stock trades above $25, you are required to sell your stock at a profit (and you still get to keep the cash from selling the right). If the stock does NOT trade above $25, you are not required to sell your stock. Of course, once again, you keep the income you received from selling the call option.
Investors who use this strategy can generate income every single month by selling new call options that expire on a monthly basis. And best of all, as interest rates increase and volatility picks up, these call options trade at higher prices – giving us more income from this overlooked strategy.
This accelerated income strategy is the basis for my IDR Plus trading service. As a general rule, I target trades that have the potential to generate an income yield of 25-35% per year. This is an income strategy that can be used in a retirement account as well as a traditional investment account, and it is actually much safer than most traditional “buy and hold” strategies.
Contrarian Profits at Their Best
For most investors, the current market environment is a lot like walking on thin ice. Everything appears normal for now, but it takes only one crack (or errant comment by the Federal Reserve) to completely change the landscape.
For us contrarian investors, however, the landscape is full of opportunity. You see, we can sidestep much of the risk simply by understanding what catalysts are likely to cause problems and also by understanding what opportunities will emerge as the environment shifts.
Today, I am more excited than ever about our contrarian opportunities. The Fed’s hand is being forced, and the era of market manipulation is coming to a close. As the Federal Reserve gradually exits, and traders throw their temper tantrums, we will be there to scoop up our profits.
To your contrarian success!
Income & Dividend Report and IDR Plus
P.S. If you’re interested in trying out my covered call service, IDR Plus, in which I provide you ways to accelerate your income, you can do so right here. My publisher has given me permission to allow readers to join my service at a discounted price of just $199. Of course, it won’t stay this low for long, so if you want to give it a try, you’ll have to sign up right away.