How to Trade the Fed Decision

While volatility has definitely picked up in recent weeks, the S&P500’s propensity to trade sideways remains the same. This summer we were stuck in a tight range between 2,170 and 2,190. Now we find ourselves marooned between 2,120 and 2,150. The more things change, the more they stay the same.

The last couple of days have been low-volume throwaways as most traders sit on their hands ahead of the Fed’s interest rate decision due Wednesday. The brief September swoon was fueled by fear of an impending rate-hike, but the reactionary selling was short-lived as the consensus quickly determined the Fed doesn’t have the courage to bump interest rates this month. In less than 24-hours we will know if the crowd got this one right.

I side with the consensus and think the Fed will hold off until the final months of the year. But just because the Fed remains stationary doesn’t mean stocks will rally. If the crowd expects no change, then that decision is already priced in. We could very well see a brief pop as uncertainty and risk evaporates following a no-change policy statement, but after that we are more likely to see a sell-the-news than a runaway rally. Delaying the first rate-hike by a few weeks isn’t going to change anything and the market is likely to see it the same way Wednesday afternoon.

While I remain bullish and expect stocks to finish the year strong, three-months is a long time and a lot can happen between now and then. Clearly the September selloff lost momentum as we keep bouncing off 2,120 support. Gone is the anxiety and fear as owners feel more comfortable following a rebound off of the recent lows. But the thing that concerns me is our inability to break out of this consolidation. If we were truly oversold, we would have bounced higher and not looked back. That means we are not oversold yet.

The longer we hold near support, the more likely we are to violate it. If we cannot escape this trading range by the end of the week, expect the next move to be lower. Breaking 2,120 support will launch another wave of reactionary selling as we trigger all the stop-losses under this widely followed technical level. That will be followed by another wave of reactive “sell before things get worse”. But not long after that, expect the supply to dry up like it did on September 9th. Most owners know a 0.25% bump in interest rates doesn’t change much and will continue to confidently hold their stocks, just like they did through the Brexit, the last rate-hike, and all the other bearish headlines that came across the wire this year. No matter what the “experts” think should happen, when confident owners don’t sell, supply remains tight and prices firm.

If we pop following a no-hike decision Wednesday, I wouldn’t chase it because we will likely run out of buyers near 2,180 like we have so many other times this year. But if we crash under 2,120 support in a sell-the-news reaction, stay calm and let other people dump good stocks for steep discounts. The most ambitious of us take advantage of the opportunity and buy the bounce off of 2,100 support. If the selloff is sharp and volume extremely high, that will finally be the capitulatory bottom we’ve been waiting for.

Jani