Don’t fight the Fed…
If there’s one Wall Street cliché to adhere to, it’s this one.
When the Fed is adjusting its monetary policy, you don’t want to be caught on the wrong side. The Fed will always be the biggest trader in the room…
Like it was in early 2019 or during the 2020 pandemic. If the Fed is accommodative or on its way toward being so, markets will rise.
High valuations won’t matter. Stocks will simply rise because there’s too much money in the system that needs to find a home.
And if the Fed tightens policy like it’s doing this year, markets can turn ugly. Valuations become important and investors get picky.
But right now, the market is ignoring what the Fed is shouting…
It will get more aggressive, not less.
That’s because Friday’s blow-out jobs report showed the economy added 528,000 new jobs when analysts were expecting 250,000. And a hot jobs market runs contrary to the Fed’s current mission.
The Fed is looking for the unemployment rate to rise so that demand drops, which in turn will help fight inflation. But this report proved the current pace of interest rate hikes is ineffective.
In fact, six minutes after the release, ex-Fed governor Randall Kroszner confirmed this notion by saying…
“A 75 basis-point rate hike is certainly on the table for September’s Federal Open Market Committee (FOMC).”
And it’s why the relief rally I mentioned on June 28 will have to soon come to an end.
So, how did the market latch on to this new narrative that the Fed will back off on rate hikes?
It’s the same thing that plagues the market repeatedly… false narrative based on circumstantial evidence.
You see, the market needs a story to match price action.
Some quote or facial expression from Jerome Powell during his press conference on July 27 probably created a buzz and gave headline writers an easy choice to make.
Headlines of a Fed that is about to back off on interest rate policy matched nicely with headlines of a Nasdaq up 20% from its lows on June 16.
Right now, the market is suffering from one big collective bout of cognitive dissonance, driven by the money-losing emotion called FOMO (fear of missing out).
And this is what justified investors to chase prices higher. But ultimately, investors will be reminded that this is no longer 2021.
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What’s interesting is how this narrative formed when the old one was proven wrong.
It started before earnings season on July 14. The market was at 3750, down 21% on the year. It looked reasonably priced with a price-to-earnings (P/E) ratio at around 16 and at its long-term average.
But then (as is the case now), the narrative had to match prices. So, the idea of a “valuation mirage” took hold.
On July 26, I identified this storyline and mentioned that if earnings would surprise to the upside, the market would rally hard.
And that’s exactly what happened. Earnings beat, the narrative of a “valuation mirage” proved wrong, and the market rallied.
But prices went too far, too fast.
So, the “valuation mirage” narrative transformed into the “Fed Pivot” narrative… a made-up story perpetuated by headlines that the Fed would back off on raising rates.
But just like the last one, this narrative will be proven wrong.
The Fed will have to get more aggressive because the only tool they have to fight inflation right now… is to hike rates more.
And I can’t imagine a market that just got out of a bubble six months ago, would come right back into one.
Regards,
Eric Shamilov
Analyst, Market Minute
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