Can Bernanke Pull A Rabbit Out Of His Hat?

By Jonathan Chen

Is Ben Bernanke a magician?

Gluskin-Sheff's David Rosenberg was on CNBC a while ago, and discussed a wide variety of economic topics, including Greece, the financial markets, and the housing sector.

What is even more interesting are comments he wrote last week about a potential shock and awe move from the Federal Reserve, in terms of a third round of quantitative easing.

During his interview this week with CNBC's David Faber, Rosenberg said that he believes a Greek default is imminent. Last week we saw equity markets rally on hopes that something positive would happen in Europe to help solve the sovereign debt issues, but we saw nothing. That is largely the reason we are giving back a lot of the gains we saw last week.

He believes that the coordinated actions of central banks around the world, including the Federal Reserve, Bank of Japan, European Central Bank, and the Bank of England helped to stave off fears about dollar funding. Rosenberg said that this is a market that will grasp onto any piece of good news.

The comments Rosenberg had in a note last week hinted about Bernanke doing the unexpected. In a note obtained by ZeroHedge, Rosenberg hinted the Federal Reserve might do something more aggressive than just Operation Twist, which is already baked into the markets. In his note, Rosenberg said that Federal Reserve Chairman Ben Bernanke may do something to shock the financial markets, and that may be an expansion of the balance sheet.

In his note, Rosenberg wrote, "The consensus view that the Fed is going to stop at 'Operation Twist' may be in for a surprise. It may end up doing much, much more. And this may be one of the reasons why the stock market is starting to rally (a classic 50%-plus retracement, which always occur after the first 20% down-leg in a cyclical bear market would imply a test of 1,250 on the S&P 500 at the very least). Hedge funds do not want to be short ahead of next week's FOMC meeting, and who can blame them?"

As part of his note, Rosenberg highlighted part of a speech from Bernanke in 2003. In his speech, Bernanke wrote, "Even the casual observer can have no doubt, then, that FOMC decisions move asset prices, including equity prices. Estimating the size and duration of these effects, however, is not so straightforward. Because traders in equity markets, as in most other financial markets, are generally highly informed and sophisticated. any policy decision that is largely anticipated will already be factored into stock prices and will elicit little reaction when announced. To measure the effects of monetary policy changes on the stock market, then, we need to have a measure of the portion of a given change in monetary policy that the market had not already anticipated before the FOMC's formal announcement."

Rosenberg seems to be hinting that Bernanke that could do something bigger than any of us expect. The market rallied last week, and most informed market observers know that Operation Twist is not going to juice the market, but a potential balance sheet expansion certainly would. We have seen tech come well off its lows Monday, and this could be a precursor that Bernanke has something else up his sleeve.

Names like Apple (AAPL), Amazon (AMZN) and other high-beta tech names are performing relatively well. Something does not add up. We will see what happens on Wednesday, but this is definitely worth keeping an eye on. Bernanke has frequently mentioned stock prices, so he could do something to boost the S&P 500 again. No one expected the Fed to leave interest rates at current levels until 2013, so this is not without recent precedent.

Ben Bernanke may not be Harry Houdini, David Copperfield or David Blaine, but he might just pull a rabbit out of his hat on Wednesday.

ACTION ITEMS:

Bullish:
Traders who believe that Bernanke will provide the unexpected might want to consider the following trades:

• Watch the leaders, such as Apple, Amazon and other higher beta names. They could be a precursor for a potential expansion of the balance sheet.

• Also consider the commodity names, such as Freeport McMoran (FCX). Copper is getting hit hard, but if Bernanke decides to expand the balance sheet further, copper is likely to move higher.

Bearish:
Traders who believe that Bernanke will not provide anything more than Operation Twist may consider alternate positions:

• If we get what is already expected, it will be a sell the news kind of day. Consider shorting the S&P 500 ETF (SPY) if this happens.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.