So far it seems like the Fed and Treasury have been playing whack-a-mole with each financial crisis that pops its head up. Will the Fed’s plan to buy some $1.2 Trillion worth of bonds resurrect the economy or is it a last resort type move similar to jabbing an adrenaline shot into someone’s stopped heart?

What happened?

On Wednesday the Federal Reserve declared that it would buy some $300 billion worth of long-term U.S. Treasuries as well as up to $1.25 trillion of government agency debt such as Fannie Mae and Freddie Mac.

Before we talk about the effects of this adrenaline shot, let’s consider how much $1 trillion really is:
The Washington Post reports that If counted out in $1,000 bills, one million dollars would be a stack 4 inches high. To reach a billion dollars, that same stack would have to be 358 feet high. To reach a trillion dollars, the stack would stand 67.9 miles high. In other words, if you spent a million dollars a day, every single day since Jesus was born, you would still be several hundred billion dollars short of having spent one trillion.

What does the Fed want to get accomplished?

The rationale behind Mr. Bernanke’s move is that long-term borrowing rates benchmarked to Treasury bonds will fall based on the Fed’s actions. This would affect loans such as student loans, car loans, mortgages and corporate debt.

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The Fed has tried this approach once before. Operation Twist took place in 1961 and was designed to lower long term borrowing rates (buying long term bonds), in an effort to encourage investment and grow the economy, while simultaneously raising short-term rates to reduce pressure on the dollar. According to research published by the Fed itself, Operation Twist in the 60s did not work.

What are the risks?

There is the risk that this move (as the previous ones) won’t work or even backfire. Fear of inflation may take hold as investors grow weary of the governments soaring budget deficit. Fear of inflation could actually send Treasury yields higher.

What was the effect?

The Fed’s announcement had far reaching effects on different asset classes, at least for the day. The U.S. dollar recorded its biggest drop against the euro. The PowerShares DB US Dollar Bearish ETF (NYSEArca: UDN) gained as much as 3.69% while its bullish cousin, the PowerShares DB US Dollar Bullish ETF (NYSEArca: UUP) dropped as much as 3.89%. Even though this doesn’t sound like much, for currencies those are monster moves.

Gold (NYSEArca: GLD) was down as much as 5% on Wednesday but reversed course and gained about 9% since. Silver (NYSEarca: SLV) staged a 14.30% trend reversal since the announcement. Investors, concerned about devaluation of the U.S. dollar are seeking safety in precious metals.

Long-term U.S. Treasury bonds spiked as much as 6%. The iShares Barclays 20+ Year Treasury ETF (NYSEArca: TLT) and SPDR Barclays Capital Long Term Treasury ETF (NYSEArca: TLO) provide exposure to long-term Treasuries.

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The reaction of equities was subdued compared to other asset classes. The Dow Jones (AMEX: DIA), S&P 500 (AMEX: SPY) and Nasdaq (Nasdaq: QQQQ) gained some 3% before retracing to “pre-announcement” levels. The Financials Select Sector SPDRs (NYSEArca: XLF) and SPDR KBW Bank ETF (NYSEArca: KBE) rallied some 10% before giving up most of their gains.

Will it work?

The Fed’s announcement and the market’s recent behavior fits exactly within ETFguide’s big picture outlook. In February we forecasted the following (available to subscribers of the ETF Profit Strategy Newsletter): “The best target for a temporary low is 6,700 for the Dow and 700 for the S&P 500. Extreme pessimistic sentiment may drive the indexes even towards Dow 6,000 and S&P 600”. The Dow bottomed at 6,440, right within our 6,000 to 6,700 target range.

On March 1st, we sent out the following Trend Change Alert notice to subscribers on record: “While the Dow Jones and S&P have dropped to multi-decade lows, the Nasdaq remains above the 2008 low. Ideally, we would like to see lower lows for all indexes brought about by a final phase of capitulation. One more up-down sequence over the next 1-2 weeks concluded by a huge down-day on high volume would be ideal. Once a bottom is found, a multi-month rally should lift the indexes by some 30%. Tuesday's 4% spike may be an indication of the initial intensity of the rally.”

At that time we recommended to lighten up on short ETFs and start accumulating broad sector ETFs as the iShares Russell 1000 (NYSEArca: IWB) and Vanguard Total Stock Market (NYSEArca: VTI).
For more aggressive investors we highlighted the Ultra S&P 500 ProShares (NYSEArca: SSO) and Ultra Financial ProShares (NYSEArca: UYG).

The market bottomed eight days later. The ensuing rally propelled the market 16% within less than two weeks. The market was already in rally mode before the Fed announced its plan.

Quite frankly, a rally was overdue (and foretold by the ETF Profit Strategy Newsletter) to relieve an extremely oversold condition. As this rally continues, credit may be given to Mr. Bernanke and his crew for saving the U.S. economy from collapsing.

What’s next?

Over the next months the market will be giving you a chance to cash out at levels you would have signed off on not too long ago. Don’t blow this chance.

While it will be important to identify the rally’s end, even more important is to know how much the market will have to drop before reaching the ultimate low. The ETF Profit Strategy Newsletter has correctly foretold every unwinding turn of this financial crisis. The March issue exams the long-term outlook in detail.

This long-term outlook is based on indicators with a track record of pinpointing major market bottoms. These indicators include: dividend yields, P/E ratios and investor sentiment reflected in fund manager’s cash holdings. A look at history shows that the market does not bottom for real, until the above indicators reach certain levels.

Indicative if its implications, we’ve dubbed them the “Four Horsemen.” Similar to the October 2007 and January 2009 high, at a time where investors will begin to feel comfortable with their portfolios again, the revenge of the four horsemen will deliver the next knock-out punch. The next leg down is likely to be more powerful than what we’ve seen over the past year. At times like these, an investment in knowledge will pay the best dividends.

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