All eyes on the Fed tomorrow … we’re coming up against strong resistance in the S&P … what could drive the S&P even higher … why tomorrow could be underwhelming
Yesterday, the Dow Jones Industrial Average completed its best October ever – up 13.8%. Let’s take a moment to enjoy that…Okay, with that behind us, let’s refocus. October is now in the past and your portfolio is far more interested in the future. Recent bullishness faces two big tests. The first is tomorrow’s Federal Reserve meeting. As we’ve been covering in the Digest, the market has grown increasingly hopeful that the Fed will make a December rate-hike slowdown pretty obvious. Such expectations can be dangerous. If the Fed disappoints, how much of the Dow’s 13.8% surge will disappear as traders regroup? On the other hand, if Federal Reserve Chairman Jerome Powell sounds even more dovish than hoped, what degree of additional gains might follow? That points us toward the second big test. The chart below shows the 12-month performance of the S&P 500. I’ve added a resistance trend line in blue.
As you can see, after setting its all-time high in early-January, the S&P has staged two meaningful rallies that fizzled.The peaks of those two failed rallies have established a clear resistance line that comes into play at roughly 4,150. That’s 7.6% higher than where the S&P trades as I write Tuesday morning. If the Fed is dovish tomorrow, the S&P stands an excellent chance of climbing to 4,150 – possibly even by the end of the week if animal spirits take hold.
But will there be enough strength to shatter this year-long resistance line?
In last week’s Trading Room video for Breakthrough Trader, Luke Lango provided his perspective.Breakout Trader is Luke’s short-term, algorithmic-based trading service. The heavy lifting of the trade analysis is accomplished by extremely powerful computers running sophisticated computations. They scan hundreds of millions of pieces of market data every week, searching for a specific combination of price action, moving averages, relative strength, and volume, among other criteria. The goal is to identify stocks that are currently breaking out and poised for a continued surge. As part of his Trading Room video updates each week, Luke provides a market overview. Let’s jump to last Thursday’s video:For newer Digest readers,
I think the stage is set for us not just to have this big counter rally to the resistance trend line, but for it to actually break above that in a manner that implies this could be a new bull market forming, and that stocks could indeed be positioned to soar in 2023.
If the Fed does surprise on the dovish side, it could support Luke’s bullish forecast by prompting a short-squeeze in the currency and bond markets
Let’s go to Bloomberg to set the stage for what’s happening:
The latest MLIV Pulse survey suggests that if the Fed Chair Jerome Powell gives any dovish signals during this week’s press conference, he might send investors scrambling.Almost half of 250 respondents polled last week said they were buying the dollar ahead of the Nov. 1-2 meeting, and about 78% expected two-year Treasury yields to go up. These bets, which worked out well through the Fed’s aggressive tightening, could go sour if Powell suggests a step down toward a 50 basis-point rate increase in December, or quarter-point moves to finish off the Fed’s hiking cycle in early 2023.
If these bets on a stronger dollar and higher bond yields do go south, you can expect traders to immediately unwind their losing speculations. Doing so would take pressure off the dollar and ease bond yields – both of which are supportive of higher stock prices.The most obvious dovish pivot from the Fed tomorrow would be some reference to a smaller rate hike in December, most likely 50 basis points. As I write Tuesday, traders see this outcome largely as a coin flip. According to the CME Group’s FedWatch tool, the implication is that 45% of traders believe we’ll see a 50 basis-point hike in December. Meanwhile, 48% believe it will be 75-basis points.
But did the Fed telegraph to the market that it will only be a 50-basis-point hike?
You might recall that one week ago from last Friday, stocks surged based on an article from The Wall Street Journal.This article suggested that some Fed members are growing cautious on the pace and size of coming rate-hikes. It speculated the Fed might be on the verge of a slowdown. From that WSJ article:
…Do [Fed members] raise rates by a smaller half-point increment in December?And if so, how do they explain to the public that they aren’t backing down in their fight to prevent inflation from becoming entrenched? If officials are entertaining a half-point rate rise in December, they would want to prepare investors for that decision in the weeks after their Nov. 1-2 meeting without prompting another sustained rally.
Here in the Digest, we questioned whether the article itself was an attempt to “prepare investors for that decision,” as the Fed could have easily done some backroom whispering to the WSJ.Luke shares a similar perspective on this article. Let’s jump back to his Trading Room video:
There’s a reason that Wall Street Journal article was released [two Fridays ago].…The journalist behind that specific Wall Street Journal article has been a mouthpiece for the Fed all year long. Whenever the Fed wants to communicate something to the media but doesn’t want to do it directly for fear of bad optics surrounding direct communication between the Fed and the markets, the Fed uses The Wall Street Journal as their messenger and that specific journalist as their messenger. The fact that that article came from that specific journalist strongly tells me that the Fed very purposefully wanted the communication to go out to the market that they were thinking about slowing their pace of rate hikes… …I think we’re set up for a bullish outcome [from Powell’s press conference].
The problems if the Fed does turn dovish
If the explosive market performance two Fridays ago in the wake of the WSJ article is any indication, stocks are going to erupt when the Fed signals it’s slowing down.Powell doesn’t want this. As we’ve noted here in the Digest, the Fed wants to ever-so-delicately hobble consumers to kill inflation. But studies show that a surging stock market makes consumers feel wealthier, which results in greater consumer spending. Translation: bad for inflation. A headache for Powell. But that isn’t the only problem. Inflation can spring back to life easier than many people realize. Richard Curtin is the University of Michigan professor who has directed Michigan’s widely-referenced consumer sentiment surveys since 1976. In a recent opinion piece for Barron’s in which he compared the inflation of the 1970s and 80s with our inflation today, he wrote:
Another critical characteristic of the earlier inflation era was frequent temporary reversals in inflation, only to be followed by new peaks.That same pattern should be expected in the months ahead.
You can be sure Powell is worried about signaling a 50 basis point hike in December, only to have to change course in the weeks/months based on new data.Here’s MarketWatch on that note:
Another worry for Powell is that future data might not cooperate.There are two employment reports and two consumer-price-inflation reports before the next Fed policy meeting on Dec. 13–14. So Powell might have to reverse course [if the Fed says it will slow down]. “If you pre-commit and the data slaps you in the head — then you can’t follow through,” said Stephen Stanley, chief economist at Amherst Pierpont Securities.
You can add to this Powell’s now-lambasted “transitory inflation” call. He must be haunted by this and incredibly sensitive about making another incorrect forecast. Given this, he’s likely hesitant to commit too much to a slowdown in December.My guess is we’ll hear a slightly more dovish tone… a reaffirmation of the Fed being data-driven… some new references to data that are moving in the direction Powell wants, tempered by a token comment about watching the data and “more work to do” … but nothing that paints Powell into a corner come December. But even if this “middle of the road” forecast plays out, it doesn’t mean there couldn’t be fireworks in the market. In fact, Wall Street’s reaction to tomorrow’s outcome will tell us a great deal about how much bullish sentiment still exists after the October rally. We’ll keep you updated here in the Digest. Have a good evening, Jeff Remsburg