Fed Speak a Jolt for the Market

Investor’s first read – Daily edge before the open
DJIA: 18,552
S&P 500: 2,186
Nasdaq Comp.:5,248
Russell 2000: 1,231
Wednesday, August 17, 2016 9:08 a.m.
Just when investors thought it was safe to go out into the market and NOT fear a Fed hike in interest rates, the Fed’s William Dudley and Dennis Lockhart said yesterday a September bump was a possibility, Lockhart hinting more than one could be in the cards before year-end.
Is this about control ?
Granted, July’s employment report was a welcome improvement over June’s paltry showing, but reports on the U.S. economy continue to be mixed, as were mortgage apps for August 12 week, down 4.0%. Housing is one of the bright spots in the U.S. economy. So why all of a sudden do we have warnings of a rate hike now ?
The Fed’s James Bullard speaks at one o’clock today. Next to Fed Chief Janet Yellen, he sports the greatest impact on stock prices among the bullpen of Fed bank presidents. Time for our hardhats ?
S&P 500’s Q2 earnings are in the process of chalking up their fifth straight decline, while at the same time posting one new all-time high after another.
Q3 is expected to be its sixth decline, with Q4 posting a gain of around 5%, but that’ s compared with a bummer quarter a year ago.
Normally, markets decline in expectation of a drop in earnings growth, but five in a row ?
Currently, 2017 earnings are expected to post a gain of 13%. Even if that happens, the S&P 500 would be pricey at 17.1 times earnings vs. a 10-year average of 15.9.
This is the second longest bull market in history (90 months) and the economic expansion accompanying it is the third longest (86 months) on record.
The S&P 500 Index is misleading, dominated by big-name stocks. Over the last 12 months, more than half of the 500 stocks have had declines of 20%, the benchmark that comprises a bear market. The mathematical weighting enabled the largest market cap stocks to offset the decline in those stocks.
Is this the beginning of a correction, the one I expected to start several months ago ?
The odds are increasing, now that the Fed is becoming more aggressive. Like I said in recent posts, if the BIG money steps aside, there is nothing to prevent a correction. If new negatives hit the market along the way, the correction can get ugly.
Gradual, “step-down” corrections have not been the norm in recent years. Today, corrections tend to be abrupt and without warning like the sharp 12%+ crunches in August 2015 and January this year.
Fortunately, institutions have been buyers on dips, in enough size to turn the market averages back up to post new highs.
But, as I have noted, these surges up have come without regard for stagnant corporate earnings and a historically over-priced stock market.
The bulls have been solely focused on a lenient Fed policy. But that may be changing, so what benchmarks will control stock prices now.
In truth, a small bump in rates shouldn’t adversely impact the economy or stock prices. Bull markets have endured with higher, even increasing interest rates in the past.
Well, it’s a relativity issue. A Fed move to tighten credit at this level is as much feared by the Street as when rates were in the high single digits decades ago.
I have wrongly suggested a healthy cash reserve several months ago, but preservation of capital must be respected. Investors do not want to spend six to twelve months recouping ugly losses when the market finally rebounds from a sharp correction.
Like so many false alarms in the past, a correction now may be history in a week or so. It is really about tolerance for risk.
SUPPORT “today”: DJIA: 18,473; S&P 500:2,171; Nasdaq Comp.:5,196
RESISTANCE “today”: DJIA:18,597; S&P 500:2,185; Nasdaq Comp.:5,244.
On occasion, I technically analyze each of the 30 DJIA stocks for a reasonable risk, a more extreme risk, and an upside potential over the near-term. I add the results of each, then divide by the new DJIA “divisor” (0.14602) to get the DJIA for those levels. This gives me an internal check on the DJIA itself, especially if certain higher priced stocks are distorting the averages.
As of August 12, 2016, a reasonable risk is 18,501 a more extreme risk is 18,404. Near-term upside potential is 18,808.
This market has defied anything I have ever seen EXCEPT that is, near market tops.
News headlines of new all-time highs attracts interest especially from investors who have not participated in this bull market. Likewise, it is forcing investment professionals (brokers, money managers, hedge funds and newsletter writers) to become more fully invested.
It is characteristic of late bull market behavior to prompt talk of a “New Era.”
I have heard the New Era talk before. It comes on stream when the market hits new highs after a long bull run at a time just about everyone concludes the market simply has to go higher and they better jump on board.
I see fundamental and technical signs that warn of a top, but then I started seeing those three weeks ago. It is a matter of how high is high, and a momentum that is self fulfilling.
Bull markets can reach unthinkable extremes when investors stampede into stocks fearing being left behind.
Then too, fear of total ruin at bear market bottoms can trigger panicky selling as investors scramble to salvage what’s left of a portfolio after a 30% -45% plunge.
Major tops and bottoms are marked by extremes. Savvy investors know this. Even so, it is a challenge for any human to resist the urge to chase running stock prices at unreasonable heights, or get chased out after a harrowing plunge in stock prices.
(So far this is not holding up)
The market is tracking a pattern for presidential election years where an administration is in its second term.* The news is bad.
Historically, these markets have declined in Jan./Feb., rallied in March then topped out in early April, plunged in May with brief rallies in June and August and a plunge into October prior to the election.
 STATUS OF MARKET: Neutral – but very, very vulnerable. Expect volatility
 OPPORTUNITY: RISK: Risk high, Profit taking justified.
 CASH RESERVE: 45%. Consider 75% now if tolerance for risk is low.
 KEY FACTORS: Outlook for Q2, and 2016 earnings questionable. Fed has market under its spell.
Note: Source of weekly economic calendar and good recap of indicators: mam.econoday.com.
*Bloomberg.com (Excellent pre-market read)
George Brooks
Investor’s first read
A Game-On Analysis, LLC publication
Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer. Neither Game-On Analysis, LLC, nor George Brooks is registered as an investment advisor. Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.