MorningWord 9/16/15: FOMC in a China Shop

by Dan September 16, 2015 9:46 am • Commentary

There is only one word that comes to mind when I see a day chart like this of the Shanghai Composite – Manipulation:

Shanghai 1 day chart from Bloomberg
Shanghai 1 day chart from Bloomberg

An easy retort would be, so what? The powers that be in China have clearly stated that they will take aggressive action to avoid a stock market crash.  That’s all fine and good, but it has been their stated intention since mid June when their largest stock market, the second largest on the planet began its now 40% decline (and counting) from its highs:

Shanghai Composite 1yr chart from Bloomberg
Shanghai Composite 1yr chart from Bloomberg

The point is, their market has already crashed. And now it’s a matter of how much it overshoots on the downside. Regular readers know that I suspect we will see a full round-trip of the one year back below 2500. What does that mean for your investment in U.S. stocks? It likely means we will be due for another bout of downward volatility has the the knock on effects of a stock market crash in China have yet to be felt on so many levels. Just one man’s opinion.

As for the FOMC rate decision. I can’t remember the last time where there was so much uncertainty as to what the Fed would do.  In some scenarios the speculation has become comical.  From yesterday: Fed Increase for Wimps: Economists Propose 1/8 Point Rate Rise. OMG!  The uncertainty of what the Fed may or may not do is causing some fairly odd volatility in stocks and bonds. Yesterday’s 1.5% rip in the S&P500 (SPX) suggested to me that buyers of stocks were either welcoming of a continuation of ZIRP (or a few more months), or are very comfortable with one rate increase coupled with very dovish language.  On the flip side, bond yields ran ahead of a potential rate increase with the yield on the 10 year Treasury yield at its highest level since late July:

1yr chart of 10yr US Treasury Yield from Bloomberg
1yr chart of 10yr U.S. Treasury Yield from Bloomberg

and the 2 year Treasury Yield broke out to new 52 week and 4 year highs:

1yr chart of 2 year U.S. Treasury Yield from Bloomberg

So maybe yesterday’s price action in stocks and bonds is what you would call a soft landing for the end of ZIRP.  But I would bring you back to what appears to be the impending disaster in China, which in my mind remains the single largest factor for trepidation on the FOMC’s part to finally raise interest rates for the first time in 9 years. I remain very cautious towards U.S. stocks. While the negative price action and sentiment of late last month might have overshot a bit, I think it’s safe to say that the swiftness of the move did not speak to capitulation, and that most every major equity index in the world remains in a steep downtrend and are currently in a precarious consolidation since the August lows.  Bargain hunt after we break the August lows and then re-test last October’s lows near 1820 in the SPX, not before.