Post Fed Trend Says Down But Seasonals Suggest Otherwise

As was expected by just about everyone, the Fed raised interest rates by .25% on Wednesday in their final meeting of 2017. This was far from their final rate hike of the cycle which is not good for the economy over the long-term. The stock market gave up much of the gains post FOMC and there were a few little cracks seen. The Dow remains the strongest index, not a good sign, while the Russell 2000 looks like it’s trying to step up and begin a run into year-end. It’s still a little early for that trend, but its behavior is mildly encouraging.

Semis continue to act poorly after being so strong for so long. Surprising to me, the banks and financials had a dismal day which could lead to a little bout of weakness here. Discretionary and transports remained solid leaders. Both industrials and materials are also continuing to lead, a good sign for the economy. The dollar, however, fell hard. At the same time, both bonds and gold rallied which creates somewhat of a quandary. Are the defensive groups correct in sensing some economic weakness or are the economically sensitive sectors right and the economy will continue its winning ways. This is vaery unusual behavior for a Fed day.

For the hear and now, any and all weakness should be bought until proven otherwise, something I feel like I have said 1000 times. Not that there are never declines this late in the year, but it’s very tough to get that selling snowball rolling downhill with any velocity. Sure, stocks could peak and decline 1-3% into year-end, but the odds favor a mild drift higher into the New Year. There’s just not many potential catalysts for a meaningful decline. I guess investors could use some of the soon to be released elements of tax reform as cause to sell, but then they would have to pay capital gains so soon.

Finally, as I mentioned in the special update on Wednesday, there is a post FOMC trend which signals some short-term weakness starting today. It’s a little muted by strong seasonals, but it’s something we should be aware of.

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Fed’s Arrogance Leading to Disaster for Economy. All the Wrong Moves

Stock Market Behavior Models for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Over the past few meetings, many of the strongest trends immediately before and after were muted except for a moderate post FOMC trend last meeting which called for mild weakness.The S&P 500 gained fractionally over that period.
Today, as with most statement days, the first model calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. If the stock market opens outside of that range, there is a strong trend to see stocks move in the opposite direction until 2:00 PM. For example, if the Dow opens down 1%, the model says to buy at the open and hold until at least 2:00 PM.
The next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 80%+, however with the Dow sitting at all-time highs with barely a hiccup in four months, the bulls exhausted a lot of energy, similar to what we saw at the last two Fed meeting 6 and 12 weeks ago. That trend’s power has been muted significantly to less than 50% which is not exactly the kind of trend worth trading.
Finally, assuming stocks close higher today, there is a trend setting up for a post statement day decline, although the seasonal strength of December puts a little damper on that.
Rate Hike Certain & Balance Sheet Reduction Update
 
Janet Yellen & Company are certain to raise the Federal Funds Rate by .25% today. It’s the worst kept secret and the markets are fully prepared. I also expect an update on the Fed’s progress in trimming its $4 trillion balance sheet although I do not believe they will make any changes.
All the Wrong Moves for Yellen & Co.
Remember the Tom Cruise movie, “All the Right Moves”? It was a football movie set in steel country PA with Cruise having to make a number of life decisions. Well, if the Fed’s plan was a movie, I would title it “All the Wrong Moves”. Their academic arrogance has sprung up again and it will not end well for our economy.
I want to stop for a moment and rehash an old, but still troubling theme. I am absolutely against the Fed hiking interest rates AND reducing the size of its balance sheet at the same time. It’s an unprecedented experiment and the Fed doesn’t have a good track record in this department. Pick one or the other. Stop worrying about ammunition for the next crisis. Given that the Fed has induced or accelerated almost every single recession of the modern era, I have no doubt that the recession coming in late 2018 or 2019 will certainly have the Fed’s fingerprints on it with their too tight monetary policy experiment.
Let’s remember that the Fed was asleep at the wheel before the 1987 crash. In fact, Alan Greenspan, one of the worst Fed chairs of all-time, actually raised interest rates just before that fateful day. In 1998 before Russia defaulted on her debt and Long Term Capital almost took down the entire financial system, the Fed was raising rates again. Just after the Dotcom Bubble burst in March 2000, ole Alan started hiking rates in May 2000. And let’s not even go to 2007 where Ben Bernanke whom I view as one of the greats, proclaimed that there would be no contagion from the sub prime mortgage collapse.
Yes. The Fed needs to stop.
Velocity of Money Still Collapsing 
Below is a chart I have shown at least quarterly since 2008. With the exception of a brief period from mid 2009 to mid 2010, the velocity of money was, is and will continue collapsing. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a disastrous bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. The economy has been suffering for many years and will  not fully recover and function normally until money velocity rallies. Without this chart turning up, I do not believe the Fed will sustainable inflation at 2% or above.

It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets. It continues to boggle my mind why no one calls the Fed out on this and certainly not Yellen at her quarterly press conference. Being her last presser today, let’s hope that someone in the media steps up!

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***Special Fed Day Alert. No Rate Hike. No Surprises***

Behavior Models for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Eight meetings ago was one of the rare times where the models strongly called for a rally on statement day which was correct as well as a decline a few days later which was also correct.

Today, as with most statement days, the first model calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. If the stock market opens outside of that range, there is a strong trend to see stocks move in the opposite direction until 2:00 PM. For example, if the Dow opens down 1%, the model says to buy at the open and hold until at least 2:00 PM.
The next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 80%+, however with the Dow sitting at all-time highs with barely a hiccup in two months, the bulls exhausted a lot of energy, similar to what we saw at the last Fed meeting 6 weeks ago. That trend’s power has been muted significantly to less than 50%. That’s not exactly the kind of trend worth trading.
Finally, there may be a trend setting up for a post statement day decline, but there are a number of rally factors that still need to line up.

No Rate Hike & No Balance Sheet Taper Update

The good news is that short-term interest rates will not be moving higher at 2:00 PM. That will likely happen at the December meeting as the economic evidence certainly supports another 1/4% hike with GDP at 3%, unemployment at new lows and consumer confidence at new highs. I also don’t expect any news on the Fed’s plan to taper the size of its balance sheet.
Six weeks ago, I offered that the Fed would announce the cessation of reinvestment of certain instruments, if not all, to the tune of $300 to $500 billion a year. It turned out that my forecast was too aggressive as Yellen’s plan began last month with a paltry $4 billion in runoff and scales up to only $20 billion per month later in 2018.
Velocity of Money Still Collapsing

Below is a chart I have shown at least quarterly since 2008. With the exception of a brief period from mid 2009 to mid 2010, the velocity of money was, is and will continue collapsing. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a disastrous bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. The economy has been suffering for many years and will  not fully recover and function normally until money velocity rallies.

It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets. It continues to boggle my mind why no one calls the Fed out on this and certainly not Yellen at her quarterly press conference.

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***Special Fed Day Alert. No Rate Hike But Changes to Balances Sheet Announced***

Behavior Models for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Seven meetings ago was one of the rare times where the models strongly called for a rally on statement day which was correct as well as a decline a few days later which was also correct.

Today, as with most statement days, the first model calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. If the stock market opens outside of that range, there is a strong trend to see stocks move in the opposite direction until 2:00 PM. For example, if the Dow opens down 1%, the model says to buy at the open and hold until at least 2:00 PM.
The next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 80%+, however with the Dow up 8 straight days, the bulls exhausted a lot of energy and that trend’s power has been muted significantly to less than 50%. That’s not exactly the kind of trend worth trading.

Finally, there may be a trend setting up for a post statement day decline, but there are a number of factors that still need to line up.

No Rate Hike But Balance Sheet Taper…

The good news is that short-term interest rates will not be moving higher at 2:00 PM. That will likely happen at the December meeting. The bad news is that Janet Yellen is going to formally announce the Fed’s plan to begin to reduce its $4.47 trillion balance sheet of treasury and mortgage backed securities. No one will be surprised with that announcement. I say it’s bad news because the economy is finally starting to show some better growth and I have my doubts whether that will be sustainable with even tighter monetary conditions.
Regarding Yellen’s plan, I expect the Fed to cease the reinvestment of certain instruments, if not all, to the tune of $300 to $500 billion a year. On a $4 trillion account, that doesn’t seem like a lot of money but it certainly is in absolute terms. Yellen has also stated publicly that she does not expect a return to its pre-crisis $900 billion, all treasury bill balance for the foreseeable future.
Velocity of Money Still Collapsing

Below is a chart I have shown at least quarterly since 2008. With the exception of a brief period from mid 2009 to mid 2010, the velocity of money was, is and will continue collapsing. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a disastrous bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.
This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. The economy has been suffering for many years and will  not fully recover and function normally until money velocity rallies.
It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets. It continues to boggle my mind why no one calls the Fed out on this and certainly not Yellen at her quarterly press conference.

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Bounce to Continue. Yellen, Draghi & Harvey

We have several crosscurrents to end the week. Before I get to them, while I believe that stocks remain in pullback mode, I do not think that the bounce I wrote about on Tuesday is over just yet. There should be some more upside left. I am slightly encouraged by the very short-term strength in the Russell 2000 although it is about to test the underside of its long-term trend, also known as the 200 day moving average. That could cap the rally. Semis continue to hang in and refuse to tip their hand. On the other hand, transports broke down yet again this week and that’s a drag.

This is all within the context of the slowest activity of the year next week. “Slow” does not mean quiet nor lack of action. There have been many market events when participants have been on vacation. Russia’s debt default in 1998 is among the worst. It pays to stay vigilant.

The Fed’s annual retreat in Jackson Hole Wyoming is happening now. Chair Janet Yellen and ECB Chair Mario Draghi are both set to speak today. If any major policy moves lie ahead, I would expect a little hint in their speeches. Additionally, Yellen could/should offer some clues on the expected tapering of the Fed’s $4+ trillion balance sheet.

On the weather front, Hurricane Harvey is set to hit the Texas coast shortly. The worst forecasts have it making landfall and then pulling back offshore for another assault on land. Weather events are very short-term and quickly reversed market events. The energy sector is where we typically see the highest impact. I wrote about energy yesterday and I still feel the same way, storm or not. Thoughts and prayers are with all those in harm’s way! Stay safe!!

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Boring Fed Day On Tap

Model for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Six meetings ago was one of the rare times where the models strongly called for a rally on statement day which was correct as well as a decline a few days later which was also correct.

Today, as with most statement days, the first model calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. The next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 75%+, however with the bulls using a lot of energy over the past few weeks, that trend’s power has been muted significantly to less than 50%. That’s not exactly the kind of trend worth trading.

Finally, there may be a trend setting up for a post statement day decline, but there are a number of factors that still need to line up.

No Rate Hike But Balance Sheet Taper…

Janet Yellen and her friends at the Fed have done an excellent job of preparing the markets for interest rate hikes this year. There haven’t been any surprises on that front. Recently, they have been chatting up a storm regarding a plan to reduce the size of the Fed’s $4 trillion plus balance sheet. You can expect to hear a little more about this in their statement today after they leave rates unchanged. With the Fed’s annual Jackson Hole retreat about a month away, Yellen and Company should continue to prepare the markets for a formal announcement in six weeks with lots of information released at Jackson Hole.

 

Velocity of Money Still Collapsing

Turning to a chart I continue to show time and time again, below is a long-term chart of the velocity of money (M2V) produced by the St. Louis Fed. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets.

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Stocks Looking Down After Rate Hike

Everything happened as expected on Wednesday. Stocks stayed in a tight range until 2PM. The Fed raised rates. Yellen spoke about reducing the balance sheet. And the bullish Fed trend was significantly muted. Given how stocks closed, there is a very short-term trend which indicates lower prices today and possibly into next week. However, with the stock market set to open lower, the opportunity to take advantage is likely gone.

The Dow is now the leading index and that’s not the index which typically leads in the healthiest of markets. I don’t expect this to continue. Mid caps have really started stepping up with small caps not looking as dead as they did a short time ago. The NASDAQ 100, on the other hand, looks like it has more downside ahead with some sideways movement coming after that.

As I always say, it’s not what the news actually is, but rather how stocks react. On Fed day, we saw good behavior from industrials, healthcare, home builders, banks, staples, discretionary, REITs and utilities. Read that sentence again. For the most part, those are not the same leaders as we have seen. Rather than the rally ending, it looks like it’s morphing after two “shock” days (big down days out of nowhere) in tech over the past month.

Now, tech may be done leading for a while, but it doesn’t look like the rally is over. Sure, we could see a pullback, but that would be yet another buying opportunity in a long line of successful opportunities.

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Fed to Hike Rates Today In Spite of Falling Inflation. Dow 23,000 Next

Model for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Five meetings ago was one of the rare times where the models strongly called for a rally on statement day which was correct as well as a decline a few days later which was also correct.

Today, as with most statement days, the first model calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. The next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 75%, however with the bulls using a lot of energy over the past few days, that trend’s power has been muted significantly.

Finally, there may be a trend setting up for a post statement day decline, but there are a number of factors that still need to line up.

It’s also June option expiration week which has historically added a nice tailwind to stocks. So far, that tailwind has been seen just on Tuesday.

1/4% Hike Against Mixed Economic Picture

Janet Yellen and her friends at the Fed have done an excellent job of preparing the markets for another rate hike today. They have been chatting up a storm in their speeches and it’s also Yellen’s quarterly news conference and economic outlook update. I would be shocked if more than Neel Kashkari dissented.

While most pundits forecast two rate hikes in 2017, I have been very clear that those expectations are too low. In my 2017 Fearless Forecast, I offered that,

“While the market is pricing in at least two rate hikes this year, I think they are on the low side. I would not be surprised to see a minimum of four increases in 2017 with the risk to the upside.”

The flaw in my thinking is that I did not believe a change in the balance sheet would be a 2017 event. We will likely hear otherwise from Janet Yellen today. Markets are expecting to learn of a plan outline to begin to curb asset purchases by the Fed sooner than later. That should eventually lead to letting assets organically roll off the balance sheet rather than outright sales in the open market. The markets would be very surprised and caught off guard if Yellen speaks about a plan to sell bonds in the open market any time soon.

I would say that today’s move has a 95%+ certainty. The Fed is going to raise the Federal Funds Rate today by .25%. Banks will then raise the prime lending rate and other rates will move off that. While the economy continues to improve, Q1 GDP was less than stellar although recently revised higher. My own work suggests that Q2 could see GDP grow close to 3% with Q3 perhaps even higher.

Monthly job creation has been very strong in four of the past five months. Only March was a lemon. I expect the growth trend to continue. The official unemployment rate hasn’t been lower since 2001 and the “real” rate or U6 is down to 8.4%, the lowest since 2007. This data certainly support a hike.

The chink in the armor and what Neel Kashkari may cite if he votes against the hike is the recent decline in inflation. From a 5 year high of 2.7% in February, the consumer price index declined in March, April and May to 1.9%. That is exactly what the Fed does not want to see as it tries to normalize interest rates.

Velocity of Money Still Collapsing

Turning to a chart I continue to show time and time again, below is a long-term chart of the velocity of money (M2V) produced by the St. Louis Fed. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets.

The Secret Behind Low Rates

Continuing to raise rates, as I have written about over and over, also makes our currency a lot more attractive to foreigners. Remember, money flows where it’s treated best. Since early 2008 here, in www.investfortomorrowblog.com and on the various financial channels, I have been a devout secular bull for the dollar, even when trillions were being manufactured by the Fed. For years, I sat alone in my bullish house before having company over the past few years.

As I have written about, I truly believe that one of the main reasons Yellen and her inner circle worry about raising rates is because they are terrified of massive capital flows into the U.S. as the dollar index breaks out above par (100) which is already did and travels to 110, 120 and possibly higher, somewhat like tech stocks did during the Dotcom boom.

Below is a chart I continue to show at each FOMC meeting. While Dollar Index bounced around between the blue lines after that huge rally on the left side of the chart, all was very well and that was normal and expected behavior. When price broke above the blue line late last year, I thought the next big move had started. I was clearly and definitely wrong.

In the strongest bull markets, price should not have declined much below 100. This has been an unexpected turn for the worse. However, I am not ready nor close to being ready to abandon my long-term positive position. If my view is going to continue to pan out, the dollar will likely spend some time going sideways before gathering itself for a run to 104 and then much higher in 2018 and 2019.

I still forecast that the final bull market price peak lies ahead and at least towards the 120 level. Nothing has changed in my long-term view that the Euro will ultimately fall to all-time lows below .80 and the Pound under par. Those are the same long-term targets from 2008.

A soaring dollar would be great in the short-term for all except those who export goods. Our standard of living would go up. Companies with U.S.-centric businesses would thrive. Foreigners would buy dollars in staggering amounts at a dizzying pace which I argue would make their way into large and mega cap U.S. stocks. Think Dow 23,000 (my most recent target), 25,000 and possibly 30,000.

What’s so bad about that?

Eventually too much of a good thing becomes problematic. In this case, mass dislocations in the global markets would grow and that would almost certainly lead to a major global financial crisis later this decade. Think many elephants trying to squeeze out of a room at the same time. Think crash of 1987 on steroids. Yellen and the other smart people in the room must know this. You may not agree with their thinking and actions, but some of these people are scary smart.

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Getting Closer to a Bottom

Stocks  begin the week on their heels after a relatively ugly day on Thursday. The pullback and selling are not over just yet, but the market is certainly closer to the end of the decline than the beginning. With Thursday’s price action closing at the low of the day and the March bottom only a few points away, I would think that the major indices are heading for a quick trip below the March lows before the bulls put up a real stand. That should occur before the end of the month.

While the stock market was closed on Friday, economic data was still released. Inflation came in a lot lower than expected and there were some downward revisions on previous months. That is exactly what Janet Yellen and the Fed heads do not want to see as they raise interest rates and float trial balloons about beginning to reduce the Fed’s massive $4.5 trillion balance sheet. Interestingly, reaction looks to be muted to start the day. Remember, it’s not what the news as much as it is how markets react.

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Going Nowhere

Well, at least last Wednesday was fun if you were a bull! The Fed raised rates by 1/4% as expected and stocks took off on the premise that there would only be two more interest rate hikes the rest of 2017. That hurt the banks and the economically sensitive sectors and gave a strong push to the defensive sectors. I remain skeptical of only two more hikes and stand by my forecast that four hikes are in the cards this year and the risk is to the upside.

Before the FOMC decision, I offered the model for the day which called for a plus or minus .50% move until 2pm and then volatility with a green close. One of our FOMC trends indicated a 75%+ likelihood that stocks would close higher. With March option expiration also last week and that being a separate and strong upside bias, the market had all of the ingredients for a rally.

However, as is often the case with outsized FOMC-driven moves, those gains or losses are usually reclaimed in the short-term. Through Friday, the S&P 500 has given back all of Wednesday’s gains. In short, the stock market’s pullback continues, however the weakness seems to be more about time than price. The major indices are moving sideways or consolidating instead of declining in price with the exception of the NASDAQ 100 which continues to power ahead, albeit at a slower pace. Both pullback scenarios serve the same purpose and should eventually lead to an upside resolution once the pullback ends, likely by early Q2.

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