Over the last several week’s I have continued to suggest that the markets could rally back to resistance. During that time, the markets have vacillated wildly between sharp declines and monster rallies.
Last week, in particular, I suggested that the market could potentially see a 2-4 week rally back to previous resistance levels. To wit:
“While the volatility index (VIX) is still suppressed relative to historical corrections, it is at the highest level since 2012. When combined with the most bearish sentiment reading we have seen since the summer of 2011, and a currently oversold market condition, the ingredients needed to fuel a short-term (2-4 week) rally are present.
The chart below shows this oversold condition, and is the same “potential reflex rally” chart I have posted for the last three weeks. The dashed blue line that I drew immediately following the initial slide has been marking the exact “reflex rally” I predicted at that time.”
The chart below is updated through Friday’s open.
“However, given the short-term oversold, bearish and fearful condition, it is extremely likely that the markets could advance to the downtrend resistance around 2040 currently. (As time passes these levels will change slightly so DO NOT focus on exact numbers for decision making – these are neighborhoods.)
ANY RALLY TO THOSE LEVELS should be used to rebalance portfolios, raise cash and reduce equity risk. I know it is monotonous, but I cannot stress enough the importance of paying attention to your portfolio at the current time.”
As I pointed out last week, 2040 was a “neighborhood,” and any rally close to those levels should be used to take actions in portfolios (guidelines below). Yesterday, the market pushed into that “neighborhood” by hitting 2020 for a brief moment until the markets realized understood what the Fed actually said.
The Fed Did It
I have written repeatedly over the last year that the Fed would be unlikely to raise rates due to ongoing deterioration in economic underpinnings. To wit:
“Currently, there is little evidence that is supportive of higher overnight lending rates. In fact, the current environment continues to support the idea of a “liquidity trap” that I began discussing in 2013. To wit:
‘…a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.‘”
“Please review the chart on monetary velocity above. This is a major issue for the Federal Reserve, which remains firmly committed to a line of monetary policies that have had little effect on the real economy.
While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility that they will anyway – “data be damned.” (Which is ironic for a “data dependent Fed.”)
They understand that economic cycles do not last forever, and that we are closer to the next recession than not. While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed’s perspective if just might be the ‘lesser of two evils.’ Being caught at the “zero bound” at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline. The problem is that it already might be too late.”
As suspected, the Fed did not raise rates this past week, which historically has been a positive for the financial markets. This was a point I made earlier this week stating:
“With markets oversold on a short-term basis combined with a spike in volatility and bearish sentiment, a “punt” by the FOMC will likely spark a short-term rally in the market. Such an outcome would NOT be surprising by any means since the market has rallied the week of an FOMC “no hike” meeting since 2013.”
As I have often stated, “You can’t handle the truth.”
However, it is important to understand that the Federal Reserve CAN NOT tell the truth. In a liquidity driven world where the financial markets parse and hang on every word uttered by the heads of Central Banks worldwide, can you imagine what would happen to the financial markets if Janet Yellen stated:
‘Despite many years of supporting the financial markets in hopes of a resurgence of economic growth, it is committee’s assessment that Keynesian economic theory is flawed. While our monetary interventions have inflated asset prices as desired, it has only served to widen the “wealth gap” while having little effect on the real economy. It is the conclusion of the committee that our policies have failed to achieve realistic economic objectives and has potentially imperiled the financial markets with a third ‘asset bubble’ in the last 15 years.’
The ensuing collapse in the financial markets would immediately create a recessionary environment. Financial markets would crumble as credit markets froze as economic activity plunged. This is why there is such a great emphasis focused on the Federal Reserve statement and the guidance they provide. This is why the FOMC continues to focus on the use of ‘forward guidance’ as a policy tool.
The problem for the Federal Reserve is that they are still looking for that elusive economic recovery to take hold after more than five years. Unfortunately for the Fed, economic recovery cycles do not last forever, and the clock is ticking.”
Understanding this, it is critically important that one reads “between the lines” of the FOMC statements. It was in the following comment that the markets received a cold dose of reality.
“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
In other words, as noted by the WSJ, there is much less confidence in economic growth.
“One official called for a negative interest rate in 2015 and 2016, something that has been tried in several European countries to boost growth and inflation. The Fed doesn’t identify which officials make specific projections.
One reason for the shifting outlook: Officials have become a bit less optimistic about the economy’s long-run growth potential. They projected the economy will grow at a rate between 1.8% and 2.2% in the long-run, down from their June estimate of growth of 2.0% to 2.3% in the long-run. A more lumbering economy has less capacity to bear much higher rates.”
NEGATIVE INTEREST RATES are not a sign of a healthy economy. And, importantly, while Yellen tried to navigate away from the idea of negative rates, she did not rule it out.
“Let me be clear that negative interest rates were not something that we considered very seriously at all today. It was not one of our main policy options
I don’t expect that we’re going to be in a path of providing additional accommodation. But if the outlook were to change in a way that most of my colleagues and I do not expect, and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context.”
And with those simple words, the 2-4 week expected rally came to an earlier than expected demise.
Source: Xfactor 09-18-15