Volatility Returns As Anticipation Builds About Fed Actions And Elections

On Wednesday afternoon, the Fed came through to fulfill what was widely expected – no change to the discount rate just yet. But it did pump up its hawkish language a bit. The FOMC never wants to surprise the markets, so given that it had not telegraphed a rate hike, it simply wasn’t going to happen. Looking forward, however, given that the committee sees the balance of economic risks at an equilibrium, a hike in December looks like a slam-dunk unless something changes dramatically. Beyond that, they are essentially telegraphing two rate hikes next year, as well. The upshot is that investors were happy and dutifully responded with a strong rally across many asset classes to finish off the day.

In this periodic 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 ETF trading ideas.

Market overview:

After the Fed announcement, the S&P 500 finished the day up +1.1% to close at 2,163, Russell 2000 +1.3% to 1,245, oil +2.6% to $45.62, and gold +0.9% to $1,339, while the VIX finished down -16.5% to close the day at 13.30. Even Treasuries were bought as the 10-year yield fell 2 bps to close at 1.67% and the 30-year yield fell 3 bps to 2.40%. Notably, the 2-year T-bill rose nearly 5 bps earlier in the day but then fell 6 bps immediately after the rate announcement before closing right about where it started the day, at 0.77%. CME fed funds futures now place 59% odds of a rate hike at the December meeting. Although there is a November meeting, no one seriously expects a rate hike right before the elections.

Investors remain generally nervous about putting their idle cash to work. Thus, there is no whiff of irrational exuberance, and many commentators see this as a contrarian sign for even higher prices in the future. Although valuation multiples are elevated, stocks still look pretty good relative to other asset classes. Bonds, for example, are not cheap.

No doubt, the economy has been overly reliant on the Fed. By keeping borrowing rates low and liquidity high, monetary stimulus has led to elevated and correlated asset prices without creating broad price inflation, mainly because the multiplier effect has been non-existent as banks have been reluctant to lend given low rates and a relatively flat yield curve. Furthermore, accommodative monetary policies have been offset by relatively tight fiscal policies, so it is time to pass the baton to our elected officials to create stimulative fiscal policies and structural/regulatory reforms that have been so badly missing. Of course, this likely won’t happen until after the November elections.

I admit that the high correlation across asset classes is concerning. After an unusually calm summer, volatility and asset correlations suddenly jumped. On September 12, the VIX briefly reached above 20, which is essentially the “panic” threshold. Stocks and bonds have been moving in tandem during September, and their correlation hit a 17-month high, mostly due to fears about Fed actions. There is real fear that the end of QE and rate “normalization” will hurt both bonds and stocks.

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Disclosure: Scott Martindale is ...

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