The Fed Explained

If the Fed was so dovish yesterday, why is the dollar spiking and why are stocks falling?

That’s a question every advisor and portfolio manager should be asking today, and if you don’t know the answer, then we invite you to try AdvsiorCheatSheet.com
I can understand why you might be confused by today’s drop in the stock market, because according to much of the financial media and the stock market yesterday, it was a perfectly “dovish hike,” and based on those reactions you could be forgiven for thinking a “Santa Claus” rally was just starting.

But as usual with markets, the devil is in the details.

The biggest takeaway from yesterday’s meeting is that the “dots” didn’t shift, and as a result a discrepancy still exists between what the market thinks will happen in 2016 with interest rates and what the Fed thinks will happen.  We believe that is a risk to markets in 2016. 

The median dots imply the Fed is expecting to raise rates 100 basis points in 2016 (so four increases) while the market currently is expecting only two (Fed Fund futures are pricing in rates below 1% while the Fed “dots” expect rates at 1.375%). 

That’s not a small spread, and either way that compression (which will happen) will present a headwind because either:

1) The Fed is more “hawkish” than they are alluding to and that will cause bonds and stocks to drop, or

2) Economic growth is going to stagnate in 2016 and the Fed will have to be more cautious (which could be very bad for stocks given current valuations).

This was the clear “need to know” out of the Fed meeting, so if your brokerage firm or subscription research didn’t 1) Prepare you for this via their FOMC preview or 2) Didn’t provide analysis like this first thing this morning, then please try our daily macro note for a quarter.

There is no long-term commitment and we believe we can help you grow your business the same way we have helped thousands of your competitors grow their businesses.

As our focus turns towards a new year, our job in 2016 will be the same as it was in 2015:

Eliminate the information overload and deliver the unemotional fundamental and technical analysis that helps our paid subscribers reassure clients, protect portfolios and seize opportunities across asset classes:

  • Stocks
  • Bonds
  • Currencies
  • Commodities

And we are delivering this macro research each day  because as we saw again this morning with markets falling, this is a quickly changing landscape and waiting a few days for a macro update from the firm’s CIO or global strategy team simply isn’t going to cut it.

Our FOMC Preview prepared our subscribers to know immediately yesterday whether the Fed was truly “hawkish” or “dovish.”  One subscriber, an advisor with Wells Fargo Financial Advisors, wrote in to thank us for providing such a clear road map for the decision.

He knew the implications of the meeting long before his firm put out any notes recapping the event, and I’m sure his larger, sophisticated clients appreciated that.

We are committed to making sure that our paid subscribers have the timely, accurate Fed analysis they need to:

  1. Alter broad asset allocations if stocks break down
  2. Identify and buy hedges to protect portfolios
  3. Know when it’s safe to expand risk tolerance

We’re not perma-bears here at AdvisorCheatSheet.com, and we like it when stocks go up because our retirement accounts and 529s are in the market.

But, the bottom line is that the two key influences on this market near term remain 1) Falling oil and 2) A surging dollar, and the Fed announcement yesterday did little to fix either of those issues.

Three Charts That Still Make Us Cautious

A lot of analysts over the past week have come out and said they “called” the latest pullback in stocks.

But, we’ve been sending you information on 1) The risks in high yield debt, 2) Oil and 3) Negative market breadth for over a month – and the proof is in your inbox.

We pride ourselves on being “ahead of the tape,” and despite a rising tide of euphoria following yesterday’s Fed meeting, we remain generally cautious on markets and need more confirmation from our leading indicators that a bottom is “in.”

Leading Indicator #1:  A Real Time Barometer on China and Global Economic Growth Fears

This leading indicator is a specific commodity ETF that has large exposure to industrial commodities – which are a proxy for:

1) Global growth and

2) Emerging market sentiment.

It has been a strong leading indicator for China/Global growth in 2015 as it broke down through a four-month uptrend in early July, right before the rest of the market got dragged down by “China and global growth” worries.

As the chart above shows, this leading indicator just dropped to a new all-time low again.

Incidentally, the last time this indicator was at a new low was on August 25th, when the S&P 500 hit 1867 (nearly 10% lower from current levels). 

Leading Indicator #2:  A Real Time Measure of Financial Stress in the US

For months we’ve been warning that with oil plunging to new 6 ½ year lows (and now approaching 11 year lows), concerns continue to rise that we will start to see stress in the junk bond markets, as a lot of risky “junk” loans have been extended to small oil companies over the past several years and bought up by bond funds who were starving for higher yield, and the health of those loans was beginning to come into question.

This concern obviously exploded onto the headlines last week with the collapse of three high yield bond funds totaling more than 2 billion dollars.

Things have calmed down this week, but it’s way, way too early to say the bottom is in, especially with oil threatening to make new lows yet again.

The last time this leading indicator hit new lows was October 5th, and the S&P 500 closed that day at 1951, nearly 3% under the Monday lows and nearly 5% from current levels.   

Indicator # 3:  Market Breadth Is Still Negative

While stocks have rallied close to all-time highs over the past month, measures or market breadth including advancers/decliners remains well below the May peak.

And when we put on a cumulative chart to smooth the data, the downtrend in advancers/decliners remains in place (we are using NYSE advance/decline, which is the standard benchmark).

This anecdotal confirms one of the fundamental reasons were are cautious on stocks – that the rally has been mostly due to positioning and concentrated on a few large cap stocks, not the broad buying that is the hall mark of a sustainable rally in stocks.

Our “Pure Play” Hedge

Because of the consistent warning signals from these leading indicators, since August we have reminded our paid subscribers of a way to hedge against oil and junk bond related drops in the stock market.  In the paid edition of The Sevens Report we have again identified an ETF that successfully protected portfolios during the August and September declines. 

During the August declines, this ETF rose 15%, protecting portfolios from the volatility.

During the late September drop in stocks, this ETF rose 6.0% compared to a -4.0% decline in the S&P 500.

Since November 3rd, the recent high in the S&P 500, to the Monday lows, this ETF is up 11.97% vs. a 5.5% decline for the S&P 500 and remains an attractive way to protect portfolios against a higher rate/slower global growth market inspired decline in stocks. 

Our paid subscribers know that we will tell them when those indicators in commodities and bonds go from flashing a “warning” sign to flashing a “crisis” sign and that we will give them specific ETFs that can protect portfolios should things get worse.

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