The Federal Reserve is apt to raise interest rates later this month, unless it doesn’t … unless it does. So went investors’ assumptions over the past week and a half.
Two Fridays ago, the S&P 500 was crushed following comments from Boston Federal Reserve Bank President Eric Rosengren, who said, “We have a good probability that we’re getting it by the end of the year.” Fed Governor Lael Brainard soothed those worries last Monday, suggesting the Federal Reserve isn’t in a hurry to raise the Fed funds rate after all. The S&P 500 rebounded in response.
That rebound was short-lived though, until Thursday when modest producer price inflation and tepid retail sales for August once again precluded the odds of a September rate hike. On Friday of last week, stronger-than-expected consumer inflation put the possibility of rising interest rates back on the table, sending the S&P 500 lower again as a result.
Perhaps it’s safe to say nobody really knows what’s going to happen on Sept. 21, when Janet Yellen and the Federal Open Market Committee have to make a decision on the matter.
But investors don’t necessarily feel they have the luxury of waiting to hear the Fed’s assessment on Wednesday to make some buy/sell decisions.
This Is Not Your Father’s Stock Market
Most investors may subconsciously understand it, but it needs to be made consciously explicit:
Thee current market environment isn’t about corporate results and the likelihood of future earnings growth. It’s not even about interest rates.
It’s about taking the pulse of the rhetoric and making a prediction about how the masses will feel about — and respond to — information in the future.
Problem: In the absence of any real economic clarity, that sort of speculation is impossible to do well, as a person’s opinion about the future changes about as often as they change stocks. That’s why the S&P 500 and all the other major market indices have been all over the map of late, yet have made no actual net movement.
It’s not always such a speculative environment, but it’s increasingly such an environment, as the reality of all that cheap money comes home to roost. That is, low borrowing costs aren’t necessarily drivers of growth — there has been no real growth in over a year.
That’s just one of several conundrums facing investors right now.
There’s also the U.S. dollar. It’s strong — still too strong by some accounts. The strong greenback is what keeps the price of oil and other commodities suppressed (it’s not great for multinational companies, either), and if there was any sector that deserved a break a falling U.S. dollar would provide, it’s oil and gas companies.
The hurdle is that rising interest rates tend to push the value of the dollar higher rather than lower. It’s an ugly catch-22.
It’s All in Your Head
Perhaps plaguing the market more than anything else right now is simply how professionals and amateurs alike are trying to apply reason and logic to it. Reason and logic haven’t mattered in months.
Instead, the market for the past few months has been something of a Rorschach test, indicating what investors want to believe about the market rather than what they know. It has not helped move stocks much higher or much lower, though, as just enough reality has seeped into optimistic view of stocks to keep all that wishful thinking in check.
It begs one key question: What is the market’s reality at this point?
It’s unlikely we’ll see the Fed funds rate tick higher this week, as much as we need a rate increase. (The annualized core consumer inflation rate now stands at 2.3%. And even if one would prefer to use the overall inflation rate and count the benefit of cheap gasoline, prices still are broadly rising. The Fed will want to tame that beast sooner than later.)
It’s also a reality that stocks are overvalued, as low interest rates haven’t helped companies expand and grow. The S&P 500’s trailing price-to-earnings ratio of 21.7 and forward-looking P/E of 17.2 are both well above the average, and the forward-looking one is built on stunningly optimistic earnings growth expectations of 26%.
The reality also suggests that traders more or less understand stocks are overvalued and due for a pullback. The persistent weakness is the red flag. These traders are just waiting to see the reason they should pull that trigger, as they continue to hear more than a few optimistic viewpoints.
Wednesday’s decision on interest rates may or may not be the catalyst. As we’ve already seen over the course of just the past few days, sometimes bad news is good, and sometimes good news is bad. At the same time, sometimes bad news is bad, and good news is good.
It’s all about the market’s mood when the rhetoric surfaces.
Bottom Line for S&P 500, Other Indices
The Federal Reserve likely will not raise rates this month. As of the latest look, the futures market is only pricing in a 15% chance of a rise on the Fed funds rate.
Superficially, that’s what investors think they want. Under the hood, though, the Fed’s unwillingness or inability to push rates higher could finally be interpreted as a sign of economic weakness that has been a little too persistent for a little too long. Stocks ran up to frothy P/E levels largely on hopes that growth would eventually justify stock prices. It never happened.
The whole thing makes Wednesday nothing more than a coin toss; bad news may actually be bad, and good news may actually be good. Regardless, the chart of the S&P 500 says investors are now more inclined to lean bearishly, putting a pessimistic spin on the headlines. With the doubters having tipped their hand, the odds of a bearish spin on whatever happens this week are higher than average.
Just know that it may take a day or two after the announcement for stock prices to reflect that reality.
It looks like we’re getting the usual September weakness, even if the bulk of it is going to be crammed into the last third of the month.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
