Traders were reaching for the Dramamine on Tuesday after an epic roller coaster session. The Dow Jones Industrial Average closed down nearly 112 points, or 0.7%, after trading 360 points higher earlier in the session.
All in all, it was an 800-point round trip as tensions grew heading into Wednesday’s eagerly-awaited Federal Reserve policy statement. One gets the feeling that we’re on the cusp of a precipice here. If the Fed can say the right thing, we could see a nice short-term rebound out of a deep oversold condition.
But if they say the wrong thing, things could get nasty fast.
That’s because we’re seeing inter-market contagion come into play. What started back in November as a collapse in energy prices has since spread to energy stocks and bonds, to the entire high-yield bond market, to the entire stock market, to investment-grade bonds, to emerging market stocks, and now, foreign currencies are under pressure.
The focal point has become Russia, which was already reeling from economic sanctions put in place in response to aggression in Ukraine earlier in the year. Now it is also suffering from the economic and budgetary impact of the near 50% drop in energy prices over the last six months.
Its currency, the ruble, is down 60% against the dollar. Inflation is around 9%. The Market Vectors Russia ETF (RSX) is down more than 50%. And its central bank jacked interest rates up to 17% in a desperate effort to stem the tide.
Indeed, the day’s intra-day bounce in the U.S. stock market was driven by word that some U.S. brokerages had closed trading in the ruble and was forcibly closing positions. That pinched short-sellers and gave the bulls the cover the needed to rally.
But it was all undermined by word from a Kuwaiti oil official that OPEC would not cut production until June at the earliest as it continues to pressure the U.S. shale industry.
Into the close, the selling accelerated as the Fed whisperers at The Wall Street Journal warned that there was a “strong possibility” that the Fed would drop the “considerable time” phrase from its policy statement tomorrow — signaling that short-term interest rates hikes are about six months away, something that hasn’t happened since 2006.
Their reasoning includes the fact that this meeting features a post-statement news conference, giving Fed chairman Janet Yellen an opportunity to explain the move. If they wait, the next news conference wouldn’t be until March.
Given November’s impressive job gains and the relative strength of the U.S. economy, policymakers could be worried this would put them behind the curve.
The chatter is that they could shift to a wording emphasizing patience when it comes to the timing and pace of rate hikes — giving them a flexibility the Fed seems to be craving in this uncertain and chaotic environment.
Investors, who have grown addicted to the Fed’s cheap money promises, are unlikely to view such a move positively. So expect more market fireworks on Wednesday. Moreover, Russia’s President Vladimir Putin will hold a news conference on Thursday and could announce efforts such as forestalling foreign bond payments in an effort to stabilize the situation and retaliate against Western banking interests.
Long story short: Investors need to remain cautious.
For the conservative, consider low-risk positions such as U.S. Treasury bonds: The 20+ Year Treasury Bond ETF (TLT) recommended to Edge subscribers is up 6.5% since it was added on Nov. 21.
For the more aggressive, there have been plenty of downside opportunities for profits including the Dec $15.50 Alcoa Inc (AA) puts that my Edge Prosubscribers closed today for a 278% gain since opening the position last Thursday as well as the 343% gain in the Dec $230 Tesla Motors Inc (TSLA) puts.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.
