A Sea of Liquidity

Bullion Vault

Once more unto the breach between stock values and common sense, thanks to the Fed…

“SO WHAT YOU ARE saying is that if the US Fed leaves rates this low, the market basically has permission to rally to new highs…even though it will have no basis in projected earnings and only stretch valuations even further?” asks Dan Denning in Melbourne for the Daily Reckoning Australia.

This was the question we put to our editorial roundtable yesterday. Kris Sayce, Murray Dawes, Alex Cowie, and Shae Smith were all there. The office was hot and sweaty. The air conditioners broke under Melbourne’s mild heat wave. But everyone at the table seemed to be in agreement:

The Fed has put a rocket under the market.

The conclusion, we think, is important to your investment strategy for the rest of this year and probably through half of 2010. The Fed is giving traders as much fuel as they’d like – via low rates – to borrow low and invest high (high yielding assets). The conclusion of the traders, the small cap guys, and the resource guys and gals in our office is that the whole market is going to float higher on a sea of liquidity.

Tactically, therefore, the editors here at the Moon Factory reckon that the way forward is up. But it’s a dangerous journey. Valuations in a credit boom go out the door. If you participate in this kind of move, you have to be aware that it’s liquidity driven (the Fed’s liquidity) and not anything else. All the editors agreed to ride it with their open positions, but to initiate trailing stops in all the positions.

Why? The reversals – and they always come – can be brutal. A trailing stop locks in at least some of your gains. So here’s a free piece of advice today: set some mental trailing stops on your open positions. No sense in not profiting from a good rally if you are in the market.

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