Will the Market Throw a Tantrum Until We See QE3?

Now that we've all digested the brats, burgers, and barbecue that come with Memorial Day, two things are official. One, my mother makes the best potato salad in the mid-West. (It might be the mix of mayo and miracle whip that really ties the flavors together.) That probably won't do much for your portfolio, so we'll move on... More importantly, the calendar is about to flip to June, and with that, the markets can focus on one thing: the end of QE2. Navigating this month will involve more than just picking out the nice stocks or picking up Raj Rajaratnam's insider tip line (1-800-WIRE-TAP). Success with your trades this summer will take some navigation through some pretty choppy waters, so remember the first rule of boating: always wear your life jacket (and always carry your drink in your starboard hand.) Your life jacket this summer trading season will be a comprehensive understanding of what is going on with QE2 and QE3, whenever the Fed gets around to realizing it needs to launch a third round of quantitative easing. How might this all play out in the next 30 days? So far, Fed Chairman Ben Bernanke has remained insistent that QE2 will end on June 30, and there will be no QE3. The market has slowly begun pricing in this theory, with financial stocks seeing a slight sell-off. They're the stocks most likely to be hammered if QE2 actually ends without any hint of a QE3. Right now, the market is somewhat hedging its bets, dividing sentiment between the idea that Bernanke is serious about no longer needing QE and the competing theory that QE3 is not only necessary, but coming as soon as this summer. Ironically, this unfocused market opinion is feeding a moderate news cycle, leaving both the markets and the Fed in a holding pattern. Neither wants to be the first to blink. If the market blinks first, the sell-off could be intense. Bear market folks might short their way to early retirement. But those are risky bets, particularly since no one knows what Bernanke will do from day to day. If the Fed blinks first, and announces QE3, the necessary sell-off will not happen. Bear market folks might still have shorted their way into retirement...forced retirement. No one knows who will get hammered if QE2 does end without a QE3 announcement. Financials make an obvious first target, but there is no guarantee that the market overall will go down. The end of easy money could drive commodity prices down, which would fuel the rest of the market upward. That would kill your short plays, wouldn't it? Then there is always the possibility that Bernanke will let QE2 expire, let the pain flow into the market, and then, finally, mercifully, offer the market the QE3 heroin it will be begging for. That scenario would make trading the news risky, but offers the most reward to those who can time it properly. Bernanke could also give clues that QE3 is coming, but never actually deliver QE3, allowing the market more time to unwind slowly. That would make short strategies more appealing, as the eventual realization that easy money is over will probably eventually end in some sort of sell-off.