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Stocks End Two-Month Rebound on Fed Fears

Stocks were under pressure again Tuesday as the chatter from Federal Reserve officials continue to talk up the chance of an interest rate hike — which would be the first since 2006 — sometime later this year. This comes in the context of a possible government shutdown and the looming start of the sure-to-be-disappointing third-quarter earnings season.

Concerning a rate hike, it’s clear the market doesn’t want it: Futures put the odds of a December rate hike at about even while the odds of an October hike are at less than 25%. Traders apparently want the Fed to drop any and all hints of a 2015 interest rate hike. And it will continue with the selloff tantrums until that is accomplished.

In the end, the Dow Jones Industrial Average lost 1.1%, the S&P 500 lost 1.2%, the Nasdaq Composite lost 1.5%, and the Russell 2000 lost 1.5%.

S&P 500

As a result, the Dow Jones Industrial Average broke down out of a multiweek bear flag pattern, setting the stage for a possible retest of the Aug. 24 “Black Monday” lows.

We’re also seeing pro-inflation assets like commodities suffer. Bond-market-derived inflation expectations are pulling back. The dollar was stronger. And the CBOE Volatility Index (VIX) is perking up in a big way.

Traders are focusing on the persistent threat of a Fed rate hike within the next three months in the context of two potential negative catalysts: The risk of a government shutdown and fiscal standoff starting Oct. 1, and the approach of the sure-to-be-disappointing Q3 earnings season.

On the latter point, Alcoa Inc (NYSE:AA) unofficially kicks things off on Oct. 8.

The Q2 season was marred by ongoing issues with foreign economic weakness, low commodity prices and a strong dollar. Those look set for a repeat performance: Ed Yardeni at Yardeni Research notes that analysts are busily cutting their estimates for the quarter. Currently, S&P 500 earnings are expected to fall 2.9% over last year.

Credit Suisse cast a pall over global growth dynamics by slashing its earnings estimates for much of its European metals and mining coverage citing soft China demand and ongoing price pressure.

No surprise then that in order to get better-than-even odds of a Fed rate hike, one must go out to the March 2016 meeting based on futures market pricing.

In corporate news, shares of Volkswagen AG (ADR) (OTCMKTS:VLKAY) dropped 16.5% in Germany as the fallout from its emissions rigging scandal. The company disclosed that upward of 11 million vehicles could be affected by “defeat device” software that turns on emission control systems only when undergoing a smog test. Points for being clever. But obviously illegal.

BorgWarner BWA

Concerns are spilling over that this could hit diesel vehicle sales and bring closer scrutiny of emissions testing in general. Ford Motor Company (NYSE:F) lost 2.8% while General Motors Company (NYSE:GM) lost 1.9%. Parts suppliers were hit harder, with BorgWarner Inc. (NYSE:BWA) slammed 7.6%.

Fresh stock market weakness is creating new short side opportunities. With volatility breaking out, I’ve re-recommended the Credit Suisse AG – VelocityShares Daily 2x VIX Short Term ETN (NASDAQ:TVIX) to Edge subscribers who enjoyed a 20%-plus gain in the position in August.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.

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