So far, the reaction to Wednesday’s Federal Open Market Committee (FOMC) announcement seems to be in line with what investors were expecting.
The Fed’s target range for the federal funds rate wasn’t raised, and inflation is near its target rate. The immediate reaction to the FOMC announcement is notorious for causing an intraday whipsaw in the major indices, so we may be surprised where the market winds up closing this week regardless of the initial relief after the announcement.
The FOMC report may also distract traders a bit from the current earnings season, which has been confusing at best. Last week’s report from Apple Inc. (NASDAQ:AAPL) is a good example of what has been happening so far.
As you can see in the chart below, AAPL’s share price rallied on the news that the company beat estimates and put concerns about iPhone sales to rest. It also announced plans for $100 billion in new share-buybacks. That all sounds great, but there is a big problem here.
Although the company announced that it would be buying back 12% of its outstanding shares, the stock only rose 4%-5% on the news. Those gains are about half of what the company experienced when it announced smaller share-buyback plans in 2012 and 2015.
In normal market conditions, we would have expected AAPL to be 10% higher (or more) following a release like this.
Apple Inc. (NASDAQ:AAPL): Chart source — TradingView.com
Concerns that this quarter is a “high-water mark” for earnings and revenue growth are persistent, but that still seems extremely unlikely. Investors have stopped upgrading growth estimates for the next quarter, but they are still expecting a percentage increase in the high teens compared to the second-quarter average in 2017.
What could still be tripping up investors are interest rates. While there has been a lot of press around the 10-year Treasury yield hitting 3%, what really matters for growth is the spread between long-term and short-term rates. To be more specific, if long-term rates rise more slowly than short-term rates, the economy could slow.
The following chart divides the 10-year yield by the two-year short-term yield. Both interest rates have been growing, but the downward trend tells us that the denominator in that equation (two-year yields) has been rising faster than the numerator (10-year yields). This is a much bigger issue for growth expectations.
10-Year Treasury Yield divided by 2-Year Treasury Yield: Chart source — TradingView.com
The Fed’s report doesn’t do much to address this issue. If inflation is hitting the FOMC’s desired target, it increases the odds for another hike later this year. Since the Fed moves the shortest-term rate, this could worsen the spread between long-term and short-term rates. While this isn’t necessarily a market-killer, it may delay a potential breakout.
The Bottom Line
Despite the weak performance of the major indices over the last several weeks, we still think the odds for a delayed bullish breakout this summer are very high. High-water marks in the past have not led to declines.
Actual earnings contractions (negative earnings growth) have been the triggers for previous bear markets, which is not a problem at this point. However, before an unknown future catalyst motivates traders to higher prices, we should expect to remain relatively balanced in our trades and focused on the very short term.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.
