We’ve written about the Fed and financial sector fallout a lot recently. Today we want to focus on the market and the ripple effects under the surface from a fundamental and technical momentum standpoint.
Broadly viewed, the fallout is what you would expect. Two weeks ago, we saw rampant, fear-based selling – there were only 86 “big money” buys and nearly 1,200 “big money” sells:
Unsurprisingly, this continued the downtrend for MAPsignals’ trusty Big Money Index (BMI), which is a 25-day moving average of “big money” buying versus selling. As of this writing, the BMI had dipped below 40%:
But in good news, the days leading up to the Fed’s decision last week saw selling come to a halt. It picked up after the Fed’s announcement but slowed again the following day. This pattern could be indicative of the market setting “higher lows”.
Digging into market sectors, the fear-based contagion caused energy, financials, and real estate to get bludgeoned. While the latter two sectors dropping makes sense, energy may not seem as intuitive: it fell on fears of energy demand draining due to a slowing economy.
Conversely, investors sought safety in technology, health care, and industrial stocks. Look at the divergence between technology and financial stocks:
All this fear colored markets red (we covered that in the past). Red in markets makes investors uncomfortable and susceptible to emotional decisions.
In these times, it’s important to step back and examine the data. Going back to Feb. 17, when the BMI fell from overbought territory, the S&P has fallen a bit more than 5%, even though it probably seems like a bigger drop. The BMI nearing oversold may indicate higher lows are in rather than having more room to fall closer to October 2022 lows.
The past 25 trading days have seen an average of 40 “big money” buy signals and 87 “big money” sell signals. Should that average continue, we’ve probably got about two weeks before hitting oversold levels.
A more bullish alternative is that selling slows more. That could still happen, though the Fed’s mix of hawkishness and dovishness in last week’s announcement makes it tough to tell which way markets will turn as of now.
We’re not saying bulls will run, but it did happen recently. Looking at the BMI chart above, similar action to now took place in the runup from December 2022 to January 2023 (before the market’s January gift). The main caveat here is that we might be somewhere in between the October 2022 lows and that December/January run. Recent selling was more severe than the winter, but less severe than the dismal September/October bottoming out of the market, especially in exchange-traded funds (ETFs):
Again, the data indicate higher lows than in the past. Markets are behaving more like the December/January run than the October 2022 lows.
It’s evident in stocks, which saw slower selling leading up to the Fed’s announcement last week:
And in ETFs:
Despite no obvious market direction yet one way or the other, we still think last week’s Fed actions will prove to be a catalyst over time. As we've already beaten to death, we know the Fed was slow with several different policy decisions going back to 2020 – namely on when to begin hiking interest rates.
Late to the game, the Fed then hiked rates at a historical clip. If hikes were earlier and slower (orange line in the below chart), things would look different today and perhaps markets would make more sense:
So, while the Fed recently upped rates again by 25 basis points, it probably shouldn’t have. Even more shocking, the central bank started quantitative easing (QE) again. The Fed’s balance sheet grew by $300 billion (and will probably grow more). To put this into context, the monthly rate of QE after the initial COVID-19 surge was only $120 billion:
So, in one week, the Fed unleashed QE at a rate that’s more than double the height of the pandemic, and nobody is talking about it. At the same time, the two-year Treasury note yield fell from 5.09% to 3.86%, as of March 17.
The bond market is screaming to cut rates! With this growing balance sheet, and the Fed hiking by 25 basis points, it is like driving a car by simultaneously hitting the accelerator and the brakes.
We know the Fed feels compelled to hike to save face. But cutting rates, or at least pausing, is what the bond market is screaming. The “higher for longer” narrative no longer applies. Unfortunately, the Fed's balance sheet will keep growing because of a banking crisis, not as a matter of policy.
At the start of COVID-19, the Fed cut the federal funds rate by 1.5% in March 2020. We don't think he needs to do that now, but rather tap the brakes.
Why? Because the December 2023 federal funds futures on March 17 closed at 96.125, indicating rates will be at 3.875% in December 2023. The June 2024 reading implies a rate of 3.395% currently. The actual rate is 4.75%, as of this writing.
We suggest a steadier hypothetical hiking cycle would’ve allowed ailing banks to have more time to adjust to rate increases and not forced bond futures to scream at Chair Powell from the mountaintop. The market is telling the Fed to cut rates, not just pause. Is anyone listening?
Safety Trades and the Market Floor
Refocusing our attention on the Fed’s effect on investors, the current strength and safety trade is in the unlikeliest of places – technology, discretionary, and industrials:
This reminds us of the safety trade in 2009-10 coming out of the financial crisis. This time around, tech, discretionary, and industrials didn't see the same intense selling as last September. Now we are waiting to see the fallout and pivots from last week’s Fed announcement. Selling somewhat seemed to return in the days immediately following, but that could be more short-term volatility in a range-bound market and we will have to keep a close eye on this action.
Chair Powell’s comments were a mix of hawkish and dovish, so time will tell the extent of the market’s reaction. We could see a higher floor than last October. However, it may not be as high as the end of 2022. If the BMI hits oversold though then we will have a strong indicator of a floor being put in (historically it doesn’t stay oversold for long).
*Links to third-party websites are being provided for informational purposes only. CoreCap is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. CoreCap is not responsible for the content of any third-party website or the collection or use of information regarding any websites users and/or members.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.