To Hike, or Not to Hike?

S&P500 Daily

End of Day Update:

Tuesday’s 1.3% gain in the S&P500 was one of the best looking day’s we’ve had in a while. We closed at the highest levels in weeks as fear of a bigger selloff continues to dissipate. But there are a lot of flaws in this strength.

Volume was light as few people traded ahead of the Fed’s rate hike decision due later this week. This reduced volume leaves the market vulnerable to larger moves because smaller traders have greater influence. Another concern is Tuesday’s intraday trade was fairly one-direction, suggesting more of a short-squeeze than legitimately fought for and earned gains. This notion is s further reinforced by the lack of a fundamental or headline catalyst behind this move. It felt like a day where people were buying for no other reason than other people were buying. While a legitimate reason can emerge to justify this move, without something substantial to support us, this strength will likely fizzle. And lastly we are approaching the upper end of a recent trading range that we retreated from a couple of times previously. In range bound markets, relief often gives way to fretting. Until we breakout and hold those gains, we should be more inclined to take profits at these levels than continue chasing prices higher.

It is hard to avoid the rate hike chatter. Will they? Won’t they? If our economy is so fragile that its fate rests on the outcome of a 0.25% change in short-term interest rates, then we have far bigger things to worry about.

Personally I think the Fed should raise rates because that is consistent with all the things they’ve been telling us. Markets are far better at dealing with bad news than uncertainty. A 0.25% rate hike now or in six or twelve weeks isn’t going to make much of a difference to anything. But the market is paralyzed by now knowing what is going to happen. Postponing the rate hike will only extend this largely unproductive debate over when the first hike will be.

We saw the same anxiety and fear ahead of Taper, but once the Fed announced Taper and started reducing its bond purchases, the market embraced that certainty and predictability, paradoxically rallying throughout the entire taper process. I have little doubt the same will happen if the Fed lays out a responsible and methodical rate hike plan. That eliminates the uncertainty hanging over us and finally lets the market focus on our steadily improving economy.

In the near-term, I have absolutely no idea how the market will react to either a hike or delay. Give me the Fed statement early and I wouldn’t know how to trade it. Only after the fact will we be able to come up with the “official” explanation for why the market rallied on a hike/delay or plunged on the hike/delay.

While we cannot get ahead of the Fed announcement, the way the market trades afterward will go a long way to telling us its mood and where it wants to go next. Will it embrace the half-full story, or obsess over the half-empty? The ideal bullish setup will be a knee-jerk selloff on a rate hike, but then the selling quickly exhausts itself and we break through 2,000 resistance. That would be the capitulation bottom of the correction. This reversal could play out over hours or weeks, but it would be a strong sign the market will rally into year-end. The harder price action to get behind will be a pop if the Fed keeps rate at zero. That is far more likely to fail since what the Fed is really telling us is they don’t think our economy is strong enough to handle a 0.25% bump in interest rates. Surely not a ringing endorsement of our economy.

Jani

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