If you thought there were a lot of rosy outcomes for U.S. stocks no matter what the Fed did (or ultimately didn’t do) yesterday, then your investment framework is one of recent years, not of the one we are in now. It’s been my view that the downdraft in U.S. stocks in August was an inflection point in the 6 year bull market. Regardless of the FOMC’s official end to ZIRP, the unwind of QE has been going on for more than a year and had manifested itself in fairly extreme volatility in almost every other asset class in the world, except U.S. stocks. Until last month. There have been bouts of volatility in U.S. stocks since the end of financial crisis, but they were primarily in 2010 and 2011 and since then its kind of been smooth sailing.
We have been vocal for the better part of the year, leading up to August, that the under-performance of the SPX, the tight range that it had been trading in, the failure of prior market leaders and generally weakening market internals had suggested we were due, sooner than later for our first 10% correction in a long time. Obviously that was a bit of guesswork, but our official party line was that we were “cautious on of committing new capital to U.S. stocks”.
The early week rally in stocks, and the weakness in bonds suggested to me that U.S. investors were looking for the FOMC to calm equity markets with their statement. And that calming may have involved the first interest rate hike in 9 years. Well, they have done the exact opposite. They have rattled an already nervous and uncertain global investment environment, and they actually pointed to the bogeyman that most hoped they would NOT I.D. The reason for their reluctance is the same as one I’ve been expressing for weeks. Here I was again on Tuesday: (MorningWord 9/16/15: FOMC in a China Shop)
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.
If I am correct that the six year bull market in stocks is unwinding, and low rates, low commodity prices will do battle with the strong dollar for months if not quarters to come, then you might want to start questioning your financial world view, and that of your investment adviser, favorite financial blogger and/or tv pundit. For the most part they have all been working off of the same playbook, which may not be well suited for what lies ahead. Which brings me back to a post from mid August (MorningWord 8/18/15: Warning Bells Scream in Silence), quoting a guy who has a pretty good line of the Fed, John Hilsenrath of the WSJ:
the Fed may have exhausted its bag of tricks: U.S. Lacks Ammo for Next Economic Crisis; Policy makers worry fiscal and monetary tools to battle a recession are in short supply
Make no mistake, a U.S. recession is coming in the not so distant future, we’re simply due. And China is already in a multi-year slowdown. I think what the FOMC said to the world yesterday is that they are on the lookout for signs that the slowdown in emerging markets is what ultimately derails our fragile recovery. The purpose of this post is not to scare the crap out of you to sell your stocks. The sell off in August should have already done that and you should have the notion of cutting losses and taking profits on the top of your to-do list on these rallies. And from the long side for bargain hunters, if we do re-test the Aug and then the Oct 2014 lows, you will have ample opportunity to play for an eventual V reversal. A recession in and of itself should not worry you, history shows that stocks can rally during them, but it is important to note that the ol’ discounting mechanism that is the stock market will sell off before that occurs.