Fed Sticks To The Script, But Not All Investors Are Comforted

Is it just me or has 2015 been a particularly crazy year? From extreme weather patterns, to a circus of a Presidential election cycle, to divergent central bank strategies, to the first triple-crown winner since 1978, to terrorist plots emanating from our neighborhoods, to counterintuitive asset class behaviors, to some of the most incredible college football finishes -- just to name a few. So, it only seems apropos to cap the year with Steve Harvey messing up on announcing the winner of Miss Universe the other night, only to correct his mistake after allowing the first runner-up to walk around with the crown for a couple of minutes before taking it away from her. It is much like the tug-of-war in stocks this year, in which the bulls walk around with the crown for a short time before the bears take it away for their own brief walk on the runway. But neither side can progress very far.

Although both the technical and fundamental pictures are murky, leading many investors to take chips off the table for the holidays, there are signs that the path of least resistance in 2016 will be to the upside.

In this weekly update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review our weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable trading ideas, including a sector rotation strategy using ETFs and an enhanced version using top-ranked stocks from the top-ranked sectors.

Market overview:

As we at Sabrient gear up for the unveiling of our eighth annual Baker’s Dozen top picks for the New Year, I am looking forward to being on the road for pretty much the entire month of January, speaking with financial advisors across the country. I was in the Washington D.C. area last week and enjoyed some great meetings with advisors there. When I am in Florida in late January, I am excited to set aside a couple of days to attend part of the Inside ETFs 2016 (link is external) conference in Hollywood, FL, which takes place January 24-27. ETF.com has provided me with a discount code to share with advisors who might want to attend: IE16-SM. If you attend this premier ETF event, please be sure to look for me.

Well, the ZIRP era has officially come to an end, at least for the foreseeable future. Stocks initially rallied on Wednesday after the Fed stuck to their long-telegraphed script and announced an initial rate hike toward normalization, accompanied by soothing words about future data-dependent but gradual rate increases. Following through as everyone expected on this initial hike was important because suddenly chickening out would have made investors think that the economy had worsened in the eyes of the Fed. Nevertheless, on Thursday things turned south, and Friday was a disaster to the downside on the second-highest trading volume of the year, which typically bodes poorly for prices in the near term. The Dow was down nearly 370 points (its worst day since September 1) and the S&P 500 fell more than -1.5%, with Financials leading the way, down -2.5%. But the S&P 500 held above 2,000, although NASDAQ lost support at 5,000.

However, I doubt Friday’s action is foreshadowing a massive selloff, as the fear mongers are saying. Many observers think that it was related to options expiration given that Friday was a quadruple-witching day, which typically creates high volatility and high volume. Moreover, many traders took chips off the table in advance of the holiday weeks. This implies that some upside (whether a dead-cat bounce or Santa Claus rally) might be in order.

Although the Fed has removed some of the uncertainty regarding rate hikes, there remains uncertainty about corporate earnings going forward, and that translates into a worry that the Fed may be tightening into a weakening economy. If a reversal of their normalization strategy is necessary, DoubleLine Capital CIO Jeffrey Gundlach observed that historically the median time from a rate hike to a reversal has been 16 months among those central banks that had to reverse course. But that would be a dramatic admission of error that seems unlikely short of a Black Swan event or a major turn of events into a recessionary spiral.

The latest Fed dot plot (with the median FOMC member's rate forecast) projects that they will raise rates about 1% per year for the next three years, rising to 2.5% by the end of 2017, then 3.5% for the longer run. But of course, it is all data dependent, and I believe that such a normalization of rates, while laudable for the long term in putting bullets back in the Fed's holster to fight off future economic slowdowns, may well have deleterious impacts on already tenuous domestic growth, or perhaps flatten the yield curve when we need it to steepen. If the Fed begins unwinding the balance sheet of QE-bought securities in an effort to support the longer end of the yield curve, it would likely reduce borrowing and threaten the housing recovery. These are tough choices that are well above my pay grade.|

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Disclosure: Author has no positions in stocks or ETFs mentioned.

 

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice ...

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