Market Preview: Placing Bets on QE3

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NEW YORK (TheStreet) -- In keeping with the "not if but when" shift in sentiment of late about additional monetary stimulus, the predictions about what QE3 may entail are starting to roll in.

Bank of America Merrill Lynch, for one, is expecting the Federal Reserve to go pretty big at its Sept. 12-13 meeting. Here's the firm's characterization of the central bank's thought process: "In our view, the Fed will move when it is comfortable that the growth slowdown is likely to persist."

With the data still pointing in that direction -- Thursday's drop in weekly initial jobless claims aside -- B of A revised its expectations of QE3's parameters to reflect a more aggressive move than previously predicted.

"We now believe that the Fed will extend its forward guidance to "at least through late-2015" on August 1, rather than through 'mid-2015.' We also expect the announcement of a $600bn QE program in Treasuries and MBS mortgage-backed securities on September 13, up from $500bn in our old forecast," the firm said. "We expect lower 5-10y rates in the near term and recommend fading any significant knee jerk back-up in rates on a QE3 announcement. We believe that QE3 will be much less effective than QE1/ QE2, both in terms of boosting risky assets and stimulating the economy."

B of A also offered up some color on the Fed's "nuclear options," which are measures it says "will be much harder to implement, but would likely be much more effective."

"These include imposing a ceiling on yields; open ended asset purchases until certain mandate triggers are met (mandate targeting); FX intervention to weaken the dollar; money financed fiscal expansion and raising the inflation target above 2%," the firm said. "In our view, the nuclear options become likely if the Fed believes the economy is sliding into recession or sees high risk of deflation."

Meantime, Scott Wren, senior equity strategist at Wells Fargo, backed the firm's year-end target range for the S&P 500 of 1400-1450 late Wednesday and offered up some advice on how to play the volatility that's likely to crop up in August when many of Wall Street's heavy hitters are on vacation and Europe basically shuts down.

"We would not advise investors to chase the market on any rally toward the highs seen in earlier in the year but those investors with a 9+ month outlook can continue to build positions in quality companies," he said.

Wren added later: "So while many investors will be spending the month of August at the beach, the financial markets will not necessarily wait for vacations to end and the kids to be back in school to before making a material move. We look for volatility to increase as we move into the fall and buying opportunities to be created. Do not get too complacent, the summer doldrums could suddenly come to an end when most market participants least expect it."

It will interesting to see if this Mario Draghi-inspired rally has any legs. At least some of the euphoric reaction to the European Central Bank president's vague pledge to do "whatever it takes" to keep the eurozone in one piece has to be attributed to the preceding weakness.

The hot topic Friday though is likely the fallout from Facebook , which no one seems to like these days.

Shares of the social networking giant fell more than 8% in Thursday's regular session then dived another 10% in after-hours action as an in-line profit was nowhere near impressive enough for Wall Street. The thing about Facebook is it's just starting life as a public company and in order to justify its current $50 billion-plus market cap (that's with the stock down nearly 30% from its IPO pricing and before Thursday's extended session decline) as well as a pricey forward price-to-earnings ratio of 41X, just meeting expectations isn't enough.

Company executives, including hoodie-wearing CEO Mark Zuckerberg himself, paid plenty of lip service to making inroads into mobile on the conference call, promising apps within apps and nixing the idea that Facebook needs to build its own smartphone. Whether any of that works (and results in real revenue momentum) remains to be seen but it's hard to escape the feeling that monetization is going to be an uphill battle, especially with Twitter in ascendance. Not offering an outlook just feeds into those doubts too.

The stock was last quoted at $23.80, down 11.3%, on heavy volume of 18.1 million, hitting a new all-time low of $23.75 in the after-hours session.

As for Friday's scheduled news, there are two more quarterly reports from Dow components on the docket, Chevron and Merck . The average estimate of analysts polled by Thomson Reuters is for earnings of $3.24 a share on revenue of $$68.56 billion from Chevron, while the consensus view is for Merck to post a profit of $1.01 a share on revenue of $12.15 billion.

D.R. Horton is also due to open its books and shares of the Fort Worth, Texas homebuilder are still sitting within shouting distance of Monday's 52-week high of $19.35. The stock is up more than 40% so far in 2012, so its earnings need to fulfill the promise of that rebound from the wreckage of the financial crisis. The appreciation has pushed the forward price-to-earnings ratio on the stock up to 20.1X.

The average analysts' view is for a profit of 20 cents a share in the company's fiscal third quarter ended in June on revenue of $1.18 billion. That compares to earnings of 13 cents a share on revenue of $961.2 million in the second quarter and earnings of 9 cents a share on revenue of $999.2 million in the same period a year earlier.

The sell side is split with 11 analysts at either strong buy (3) or buy (8) and the other 11 analysts at hold (9) or sell (2). The median 12-month price target of $19 points to valuation as a bone of contention with the stock closing Thursday's regular session at $18.80.

Citigroup thinks the homebuilders as a group may have gotten ahead of themselves and the firm is expecting names in the sector to grind lower over the next few months.

"We expect homebuilder stocks to continue the valuation correction period post the 48% YTD (mean) run in the stocks," Citigroup said Thursday. "We remain constructive on a prolonged multi-year recovery in housing starts/sales, but we continue to believe that homebuilder stocks, on average, are not discounting in the number of years it may take to return to mid-cycle starts/sales."

As for D.R. Horton, the firm is predicting another above-consensus performance.

"We project revenue of $1,208MM, housing GM of 17.5%, housing SG&A of 10.6%, and EPS of $0.28, versus consensus of $1,177 million, 17.0%, 11.7%, and $0.20, respectively. We project net orders of 5,545 units, closings of 5,323 units, and an ending backlog of 6,411 units, versus Street expectations for net orders of 5,615, closings of 5,310, and a backlog of 6,487," Citigroup said.

Check out TheStreet's quote page for D.R. Horton for year-to-date share performance, analyst ratings, earnings estimates and much more.

Other companies reporting Friday include Advanced Semiconductor , Arch Coal , Barclays Bank , Belo , Calpine , Celestica , KKR & Co. , Legg Mason , McClatchy , Newell Rubbermaid , Newmont Mining , Pilgrim's Pride and Weyerhaeuser .

Friday's economic calendar brings second-quarter gross domestic product at 8:30 a.m. ET and the final University of Michigan read on consumer sentiment for July at 9:55 a.m. ET.

The consensus estimate is for GDP growth of 1.2% in the second quarter, down from 1.9% in the first quarter. Jim Sullivan, chief U.S. economist at High Frequency Economics, sees the number coming in at 1.5% and is looking for a revision of the first-quarter growth higher.

And finally, Starbucks took a hit in late trades as well after the coffee company missed Wall Street expectations with its fiscal third-quarter results and gave weak guidance.

The company reported a profit of $333.1 million, or 43 cents a share, in the three months ended in June on revenue of $3.30 billion, falling short of the average estimate of analysts polled by Thomson Reuters for earnings of 45 cents a share on revenue of $3.33 billion.

Seattle-based Starbucks also forecast fourth-quarter earnings of 44 to 45 cents a share and said it expects earnings of $2.04 to $2.14 a share in fiscal 2013. Both those ranges are below the respective consensus estimates for per-share earnings of 48 cents and $2.28. The stock was last quoted at $47.19, down 10%, on extended volume of 3.4 million.

Surprisingly, Amazon.com was holding its own after a ho-hum quarter where the online retailing behemoth scratched out a profit of $7 million, or a penny per share, on revenue of $12.83 billion. The latest results included a net loss of $65 million related to the acquisition and integration of Kiva Systems.

That performance compares to the average estimate of analysts polled by Thomson Reuters for a profit of 2 cents a share in the June-ended quarter on revenue of $12.88 billion and earnings of $191 million, or 41 cents a share, in the same period a year earlier.

The outlook was also rather dim as Amazon forecast an operating loss of between $50 million and $350 million and revenue ranging from $12.9 billion to $14.3 billion for the third quarter. Wall Street's current consensus estimate is for earnings of 14 cents a share in the current quarter on revenue of $14.09 billion. The stock was up less than 1% in late trades.

--Written by Michael Baron in New York.

>To contact the writer of this article, click here: Michael Baron.

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