Stock Quotes in this Article: GLD, LO, MCP, MO, NFLX, NGG, OIH, PM, RAI, T, USO, VZ

WINDERMERE, Fla. (Stockpickr) -- The end of quantitative easing is quickly approaching, and investors need to be prepared for how the markets will behave once the Federal Reserve stops its bond-buying program.

In just 24 days, the Fed will have completed its controversial stimulus program in which it bought $600 billion in Treasuries beginning back in November 2010. There’s no debating that QE lifted U.S. equity prices and helped to maintain low interest rates. That said, the new debate that’s going to play out now is whether or not QE actually helped or hurt the economy.

Fears that QE might have had little effect on the overall U.S. economy were fueled with Friday’s jobs report. The Labor Department report showed that only 54,000 jobs were created in May, vs. a rise in nonfarm payrolls of 232,000 jobs in April. The report also showed that the unemployment rate jumped to 9.1% in May from 9% in April.

Why has all of the QE the Fed has initiated had such little effect so far on the U.S. economy? The simple answer is the events did not unfold as the Fed had hoped. The Fed wanted to see banks lend money and for large companies to hire new workers. Instead, corporations did little hiring and used their cash for strategic takeovers. The banks hoarded cash and instead of lending, raised their credit standards so high that few consumers were able to borrow money.

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    The only winners off of all of the QE were the speculators in things such as soft commodities, gold, silver and U.S. equities. The U.S. dollar was a big loser, as were retirees who received little return on their savings that they had worked so hard for. All of the cheap cash found its way onto Wall Street, where liquidity is always king. Hedge funds and other large speculators used the easy money to put on their favorite “risk-on” trades to take advantage of QE. That excessive liquidity is what drove silver to close to $50 and gold to over $1,500 an ounce.

    Fast forward to today, and you can see that the Fed is going to have some tough decisions to make in the near future. Since it looks like the economy is going to get weaker again, judging by the recent jobs report and U.S. housing data, then it’s more likely that the Fed will continue to do more QE. The Fed might be better off letting the economy take its medicine instead of injecting more liquidity into the system. That medicine would probably come in the form of deflation, which Fed Chair Ben Bernanke doesn’t want to see.

    The $64,000 question is how the market will react to more QE. From my end, I think the market would be in far better shape if QE were stopped, because it would mean that the economy was finally back on track -- or at worst it would mean the Fed was going to allow free markets to work themselves out. That said, a third round of quantitative easing, or QE3, might be seen as a desperate move by the markets, since QE2 has failed to show any significant economic gains.

    The Fed has really painted itself into a corner here. I wouldn’t expect stocks to rise unabated again if we do get a third round of QE. If the fed decides to do more QE, we could easily end up with an environment where inflation for the things we need to buy takes off again and we still get little job growth.

    Here‘s a look at some stocks that investors can play off an end to QE2 -- as well as a few stocks for the possibility of QE3.

     

    Tobacco Stocks

    If the economy slips back into a deflationary environment as it likely would with the end of quantitative easing, then investors should look for companies that are able to maintain prices even if assets prices are dropping. One of the best sectors for this is tobacco stocks. There have been plenty of studies that have shown that smoking increases during bad economic times, and we all know that cigarette makers don’t need to lower prices due to the addictive nature of their product.

    I would look at Altria Group (MO), Reynolds American (RAI), Phillip Morris International (PM) and Lorillard (LO). Altria, Reynolds and Phillip Morris are all trading at or very close to their 52-week highs, and all four stocks have very attractive dividend yields, with Altria Group at 5.5%, Reynolds at 5.5%, Phillip Morris at 3.7% and Lorillard at 4.8%.

    Keep in mind that if we do get deflation, the average stock is going to drop since the overall broad U.S. markets will sell off. Stocks generally don’t do well when asset prices are being revalued lower and risk is taken off. I can’t stress more how important it will be to put on your trend-following hat, since following the trend will be the only way to beat the markets. This means you must watch the markets closely to see which sectors and stocks don’t go down.

    Netflix

    With trend-following in mind, take a look at Netflix (NFLX), which has been trending higher as the market has been dropping for the past couple of weeks and earlier today reached a new 52-week high before reversing. This is an example of a stock with relative strength that traders aren’t willing to sell, even when the market trades off.

    I believe this trend in Netflix would continue even if we get deflation because consumers aren’t going to give up cheap entertainment when the economic environment around them is crumbling. Netflix would also have pricing power since its services are already reasonably priced. All Netflix would have to do is add more value, and customers would probably accept any modest price increases.

    Telecom & Utility Stocks

    Another way to win in deflation is to buy high-quality dividend stocks. I would circle the telecommunications and utilities sectors because they should be able to maintain some pricing power since their services aren’t easily cut by consumers who need to have electricity and operating phone services during even the toughest economic environment.

    The telecom names I would consider here are Verizon (VZ) with its 5.5% yield and AT&T (T) with its 5.6% yield. If you want to play the utilities, take a hard look at National Grid (NGG), which has a whopping yield of 7.7%.

    Some other high-yielding utilities are Duke Energy (DUK) at 5.3%, Exelon (EXC) at 5.1% and Pacific Gas & Electric (PCG) at 4.3%.

    QE3 Stock Plays

    If the Fed decides to implement QE3, then investors should consider that the U.S. dollar is going to lose even more value that it already has, which should boost precious metals such as gold and silver and crude oil prices. Crude oil could see the biggest upside of a QE3 because it’s priced in dollars around the world, and that correlation trade could accelerate. Let’s not forget that if soft commodities prices go up again under a possible QE3, then it will mean more social unrest in oil-rich nations, many of which are already economic nightmares.

    I am speaking mainly about the Middle East nations here, including Saudi Arabia, Libya and Iran. Any crisis scenario that hits oil-rich nations in the Middle East will cause oil to skyrocket. That’s why you’re not seeing oil boom right now due to the unrest in Syria -- it isn't a big enough oil player on the world stage to move the markets.

    If you want to position yourself for QE3, then wait for the SPDR Gold Trust (GLD), Oil Services HOLDRs (OIH) and the United States Oil Fund (USO) to pull back notably and then load up on some shares. The iShares Silver Trust (SLV) has already experienced a big pullback due to margin hikes by the CME Group (CME).

    Rare Earth Metals

    One other way to play more QE3 from the Fed is with rare earth metals stocks. This sector basically hits on three major fronts that would almost certainly benefit these stocks during a high inflationary environment caused by more quantitative easing: pricing power, strong demand and the perception of having a precious metal status like gold and silver. Obviously, rare earth metals aren’t held in the same light as gold and silver, but that could change rapidly if the U.S. dollar were to break to new all-time lows during another round of a massive quantitative easing.

    The best-of-breed name in this space is Molycorp (MCP) with its $5 billion market cap. This company has a great balance sheet, with over $492 million in cash on the books and just $2.8 million in debt.

    If you want to play this space with more speculative names that might have even more upside, then look at Avalon Rare Metals (AVL), Titanium Metals (TIE), General Moly (GMO) and Rare Elements (REE). Again, these names are highly speculative, but if we get another round of quantitative easing, they are going to look very attractive.

    If you think QE3 is coming, then look to buy the rare earth names on pullbacks. More importantly, buy them off of support zones so you aren't trying to catch a falling knife.

    To see more QE stock plays, including Newmont Mining (NEM), Barrick Gold (ABX) and Silver Wheaton (SLW), check out the Quantitative Easing Stock Plays portfolio on Stockpickr.

    -- Written by Roberto Pedone in Winderemere, Fla.

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    At the time of publication, author had no positions in stocks mentioned.

    Roberto Pedone, based out of Windermere, Fla., is an independent trader who focuses on stocks, options, futures, commodities and currencies. He is also an outside contributor to Beconequity.com and maintains the website Maddmoney.net, which he sold to Blue Wave Advisors in 2008. Roberto studied International Business at The Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany.