An Interest Rate Hike Could Be a Momentum-Killer for Markets

U.S. equities moved higher on Tuesday thanks to a rebound in the large-cap tech stocks that have been dominating the popular psyche on Wall Street lately. You know the ones, which carry toothy monikers like “FAAMG” depending on the composition, including the likes of Facebook Inc (NASDAQ:FB) and Amazon.com, Inc. (NASDAQ:AMZN).

The rebound helped push the major averages to fresh record highs as the Federal Reserve begins its two-day policy meeting.

In the end, the Dow Jones Industrial Average gained 0.4%, the S&P 500 Index wafted up 0.5%, the Nasdaq Composite added 0.7% and the Russell 2000 finished the day up 0.5%. Elsewhere: Treasury bonds were little changed, the dollar was lower overall, gold was mostly flat and oil gained 0.8% after reversing early weakness.

Breadth was heavily positive, with 2.4 advancers on the NYSE for every decliner while volume was 93% of the 30-day average. Materials stocks led the way with a 1.3% gain while telecoms were the laggards down 1%.

Hertz Global Holdings, Inc (NYSE:HTZ) gained 8% and Avis Budget Group Inc. (NASDAQ:CAR) gained 3.3% thanks to an NADA upward revision to used car values an area of recent concern amid fears of an off-lease flood into the secondary market. Tesla Inc (NASDAQ:TSLA) gained 4.7% on an upgrade at Berenberg on hopes for cash generation as production reaches scale. On the downside, Cheesecake Factory Inc (NASDAQ:CAKE) fell 9.9% on guidance for Q2 same-store sales -1% versus the gain the consensus was looking for.

On the economic front, all eyes are on the Fed’s policy announcement Wednesday afternoon. Futures market odds of another quarter-point Fed rate hike are all but assured (99%-plus). But the thing to watch will be how the Fed responds to a mixed economic environment (unemployment rate at 4.4% and inflation above 2% but GDP growth and retail sales tepid) and very wide rate expectations gap (futures market expects interest rates at 1.75% at the end of 2019 versus 3% for Fed officials).

Bank of America Merrill Lynch economist Michelle Meyer believes it will be hard for the Fed to deliver the “dovish hike” it would prefer to do: Tightening rates to keep a lid on inflation and asset price gains, but not spooking the market. In Meyer’s words:

“The market notably reduced its hike expectations following the March [policy meeting] making it difficult for the Fed to sound more accommodative than current pricing.”

 

Adding to the difficulty was a rather hot producer price inflation report on Tuesday: The “core” inflation rate increased from 1.9% to 2.1%, above the Fed’s target. Assuming a strong retail sales and consumer price inflation report Wednesday morning, before the Fed’s policy announcement, chairman Janet Yellen will be hard pressed to justify with a straight face the dramatic lowering of rate hike estimates Wall Street wants to see.

Conclusion

 

For years, it has paid to bet the Fed gives the market what it wants to hear. Nearly every major Fed milestone, whether it was the start of the tapering of QE3 or the start of rate hikes in 2015, the Fed has managed to soothe investors and still accomplish its goals.

So, it’s hard to believe tomorrow will suddenly mark an end to that dynamic, although it is technically possible.

Sentiment could hardly be hotter. The NFIB Small Business Optimism Index remains near all-time highs (despite a lack of progress on legislation from the Trump White House) with hiring activity near the highest levels in the survey’s 43-year history despite a tight job market.

In the market, positions look crowded and valuations are trying (cyclically-adjusted, price-to-earnings ratios have only been higher in 1929 and 2000). A Bank of America Merrill Lynch fund manager survey found the highest percentage of investors on record believe equities are overvalued and that the number one most crowded trade was long Nasdaq. Yet today’s buy-the-dip rebound shows no one wants to be the first out the door and miss out on any subsequent gains.

If, however, the Fed does shock with a hawkish announcement, press conference, and economic projections, last week’s tech selloff shows just how rapidly recent price gains could reverse if the momentum breaks. Especially heading into Friday’s options expiration. Get the popcorn ready.

Check out Serge Berger’s Trade of the Day for June 14.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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


Article printed from InvestorPlace Media, https://investorplace.com/2017/06/dow-jones-hit-record-close-ahead-of-fed-decision/.

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