Fed ‘Patience’ Drives Massive Stock Surge

The market volatility that has rattled investors over the past month continued on Wednesday in the wake of the last Federal Reserve policy statement of 2014. Only this time, the volatility was to the upside.

Stocks blasted higher in what was the best one-day gain for large-cap stocks since early 2013 (which was in response to relief over the last minute fiscal cliff deal), pushing the Dow Jones Industrial Average up 1.7% to cross back over its 50-day moving average. The S&P 500 gained 2%, the Nasdaq Composite gained 2.1%, and the Russell 2000 gained an impressive 3.1%.

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The Fed statement was slightly more dovish than expected, with policymakers adding that they would be “patient” when it comes to the pace and timing of its rate hikes in 2015. The “considerable time” language was maintained, which was a slightly more dovish-than-expected outcome. In her post-announcement news conference, Fed Chairman Janet Yellen said that the “patient” language translated to no rate hikes for the next two meetings.

But she also dismissed the deflation risks of the collapse in oil prices (saying this equated to a tax cut to consumers), didn’t seem concerned about the recent collapse in market-derived inflation expectations, and emphasized that rate hikes were indeed coming sometime in 2015. All of this was slightly hawkish.

At the end of the day, it boiled down to this: The Fed will likely tease a June rate hike at its April policy meeting, assuming U.S. economic growth and job creation is maintained at current rates.

For markets, which have been battered by the fallout from the collapse in energy prices and the anticipation of the negative impacts from this (energy sector bond defaults and trouble for oil-exporting countries like Russia) the response to the Fed news was a little bipolar.

The U.S. dollar strengthened, pushing crude oil down from its intra-day highs, suggesting currency traders viewed the Fed’s announcement as slightly hawkish. Precious metals and Treasury bonds were also pushed lower.

But stocks soared in what looks like panic buying driven by forced short covering. Indeed, there were more than 2,900 net advancing issues on the NYSE — the broadest one-day participation in nearly two years. And an index of the most shorted stocks in the market posted its best one-day gain since 2011. All this suggests equities believed the Fed’s announcement was more dovish.

The explanation probably involves the all-important yen carry trade, which computer trading algorithms have begun to rely so heavily upon that most days, stocks track the movement of the Japanese yen versus the dollar on a tick-for-tick basis.

If that was the catalyst for today’s rebound, it suggests that the bounce — which is likely, based on technical and seasonality to continue through the end of the year — will run into new headwinds in early January as the negatives of the collapse in oil prices remain in play.

These include a drop in energy sector investment, a possible slowdown in hiring, pinched S&P 500 profit growth, and the very real risk of financial contagion coming out of the high-yield bond market or an oil-exporting emerging market country.

Indeed, the bond market seems decidedly less enthusiastic than stocks are, with energy bonds underperforming the rebound in energy stocks today.

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Heading into the session, I recommended subscribers book profits in defensive positions to raise cash ahead of the volatility that was sure to follow the Fed announcement. Examples include the 518% gain in the Dec $28 iPath Short-Term VIX (VXX) calls enjoyed by Edge Pro subscribers and the 9.5% gain in the ProShares UltraShort QQQ (QID) earned by Edge subscribers over the past week.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.


Article printed from InvestorPlace Media, https://investorplace.com/2014/12/fed-patience-drives-massive-stock-surge/.

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