What to Expect for US Equity Markets

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Editor’s note: Murray Dawes is the editor of Alpha Wave Trader, a short-term trading service that trades stocks and indices from the long and short side. He is filling in for Harje while he is away overseas.

As I watch the S&P 500 slowly march higher day after day, just a few short months after it looked like the world was going to end, I shake my head in disbelief about what the markets have become.

I’m happy to put my hand on my heart and say that I got this wrong. I’m literally amazed that the US equity markets have recovered the prior fall without once having a correction.

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The US Fed is focused on the state of the equity markets

I guess the cat is out of the bag that the US Fed is 100% focused on the state of the equity markets, despite their constantly denying it.

After 10 years of pumping the markets higher to escape the GFC, I honestly thought we had finally reached the point where the powers that be would attempt to normalise rates. If only in fear of creating a larger monster down the track if they didn’t act.

I had read the speeches by Chairman Powell. He talked tough years ago, saying that he thought the Fed was being too loose in its policies and was creating a moral hazard by bailing the market out every time there was a whiff of a problem.

The glaring catch 22 was put on full display at the start of the year, when the threat of rising rates caused markets to fall, leading to the Fed backing down from raising rates.

The stability of the system is now so brittle that a fed funds rate above 2.5% can’t be handled.

Yahoo Finance news is saying that Trump is asking the Fed to lower rates by 1% even as the equity markets hit new all-time highs! Huh?

I can remember when Trump was criticising the Fed for keeping the party going for too long. But now that he’s President, he wants them to keep rates as low as possible. Gee, what a surprise.

So how does this play out from here?

The S&P 500 is nudging right up against the all-time high after rallying in a straight line for four months. The market is well and truly overbought in the short term, but a solid move above the all-time high may very well ignite a melt-up rally.

The shorts will have thrown in the towel by now with a few stragglers left if we head a bit higher.

The FOMC meeting wraps up tonight and we’ll get an announcement at 4am Thursday morning Australian Eastern time. No change is expected, so a cut in rates would create some mayhem, but I’d eat my hat if they cut rates while growth is picking up, unemployment is below 4% and equity markets are hitting new all-time highs.

I expect their commentary to walk back some of the kitchen sink talk of the last few months. The market may not like that one bit.

This is the tightrope that the FOMC is now walking. Every word is analysed to the nth degree. The market crashing or going vertical all comes down to the turn of phrase in a document.

That is not a free market.

What will they do if the market does go vertical from here? How silly will they look if they turn around in six months with the equity market up another 20–40% and start raising rates again? Maybe they don’t care anymore. They’re so far into the unknown that we may need to see things get completely out of control before they will act.

The 1970’s inflation didn’t get under control until Paul Volcker stepped in as Fed Chairman and raised rates to eye watering levels to stop the rot.

Maybe that is the cycle the Fed is going to take. Keep pushing things until there is no option other than to collapse the economy and start again.

The Fed makes the rules

If you were a Fed Chairperson what would you do? Kick the can down the road and go to lots of nice dinners, or ignore the markets tantrums and restore some sanity? Kicking the can is really the only option left. The game of pass the parcel will go on until it can’t go on anymore.

What is a trader to do in such an environment? You can’t fight the Fed. If they do ignite a melt-up rally there will be plenty of money to be made, so you have to go with it. But you need to have your eyes on the exits because we will be entering the blow off phase of a 10-year bull market, and they rarely end well.

Every announcement by the Fed from this point on should be read carefully and the market’s reactions to those comments analysed to look for clues that fatigue is setting in.

I felt supremely confident that we were close to a correction just recently. Now I am happy to say that I am not sure what comes next. A breakout above the all-time high and a melt-up rally is feasible. So is a false break of the all-time high and a sharp correction from overbought levels. My gut feel is that it will be the latter, but a blow off rally will still occur at some point.

Which one we get may hinge in the short term on the comments made during the FOMC meeting being held tonight.

As a technical analyst there is always the temptation to ignore all the extraneous factors affecting the markets and just read the charts. But when it comes to the US Fed you must accept the fact that they make the rules that we all play by.


Murray Dawes,
Editor, Alpha Wave Trader

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About Murray Dawes

Murray Dawes is the Editor of Pivot Trader and contributing Editor at Money Morning. He was one of five, from 5,000 applicants, chosen for a graduate position with the Swiss Banking Corporation — now part of banking giant UBS. The bosses quickly cottoned on to his potential and pushed him…

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