Stocks Rattled as the Fed Turns Hawkish

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Stocks were rattled on Wednesday by waves of trading volatility as the release of the Federal Reserve’s October meeting minutes confirmed that the cheap money junkies on Wall Street have been fearing for months: the Fed, newly confident about the health of the economy and job market, is preparing the first interest rate hike since 2006.

In the end, the Dow Jones Industrial Average lost a fraction, the S&P 500 lost 0.2%, the Nasdaq Composite lost 0.6%, and the Russell 2000 lost 1.1%.

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Retailers got a big lift thanks to earnings and hopes that the holiday shopping season this year gets a big boost from lower energy prices. Target Corporation (TGT) gained 7.4% while Staples, Inc. (SPLS) added 9.1%.

The day’s action came as a bit of a shock to many since the S&P 500 is coming off of its tightest trading range in market history and has now spent  24 consecutive days above its five-day moving average. The all-time record is 27 days set in March 1986, in case you were wondering. The harrowing market decline into the Oct. 15 low is ancient history now.

The minutes themselves reaffirmed what we learned from the October Fed policy statement — that quicker-than-expected gains in the job market resulted in the end of the “QE3” bond purchase stimulus in October and will likely lead to a short-term interest rate hike sometime in the first or second quarter of 2015.

Possible concerns, from October’s market rout to weakness in Asia and Europe and the drop in inflation pressure from lower crude oil prices, were set aside.

While large-cap stocks are doing their best to ignore the reality that higher interest rates are coming, other areas of the market are coming to.

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High-yield bonds as represented by the iShares iBoxx $ High Yield Corp Bond (HYG) tipped into the strongest downtrend since September on expectations of higher rates. The small cap stocks in the Russell 2000 have dropped below their 20-day moving average for the first time since early October.

And volatility as represented by the CBOE Volatility Index — known as the VIX, or Wall Street’s “fear gauge” — has diverged from stocks to inch higher over the last two weeks as options traders bid up put option protection against a possible market decline.

Remember that the stock market’s rise over the last few years has been predicated on low wage inflation and easy Fed policy. That’s acted as the raw fuel needed to push up corporate profits to record highs. And stocks have benefited both from the rise in profitability but also in the ability of CEOs to use low rates to leverage up corporate balance sheets and use the proceeds of debt issuances to buyback their own shares.

All of this is threatened by the tightening underway in the job market, the rise in junk bond yields and the approaching start of the Fed’s first rate hike campaign since 2004.

But the Fed will probably take a back seat now, with no major events scheduled until December, to the machinations in Washington ahead of President Obama’s immigration reform announcement on Thursday and the likely Republican pushback against his executive action. This could potentially jeopardize the need for a budget resolution by Dec. 11 and the need to take action on the debt ceiling by March.

The combination of a tighter Fed, higher rates and another fiscal standoff could put new pressure on stocks as we head into 2015. All this, combined with deteriorating market breadth measures and extended investor sentiment, has me skeptical about the longevity of the S&P 500’s two-month resistance to any significant pullback.

As a result, I’m recommending Edge subscribers raise cash and focus on the Credit Suisse AG – VelocityShares Daily 2x VIX Short Term ETN (TVIX), which is up 4.6% since Nov. 10. Edge Pro subscribers just booked an 85%+ gain on their SPDR Gold Trust (ETF) (GLD) calls.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/11/stocks-rattled-fed-turns-hawkish/.

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