According to the CME FedWatch Tool, the probability of a rate hike on March 15th stands at 88%. A window has opened allowing the FED to raise rates; unemployment is down to 4.7%, hourly earnings continue to rise (2.8% y/y), and inflation in January was 2.5%. The FED has been preparing the markets for a hike since December '16 when inflation started to accelerate, so they are not about to waste two months of effort-they will raise rates, and the market won't mind.
To be honest, we think the main reason the FED will raise rates next week --apart from the desire not to fall behind the curve which would require bigger and faster tightening later--is to have a cushion in the event that a future problem necessitates a rate cut. The FED has two tools; control over the cost of money it lends to the banks (FED funds rate), and quantitative easing. The former tool was totally spent with no room to cut rates, and the latter requires increasing the money supply which risks causing inflation. If the economy needs help in the future, rate cuts are favored over QE because QE carries inflation risk.
A rate hike now, is not expected to hurt the market in the same way that rate hikes affected markets between 1980 and 1998. During that period, rates and the SPX had a negative correlation; rates up, SPX down (Chart below).
Between 1998 and 2011, rates and the S&P 500 moved in tandem; rates up, SPX also up (chart below).
Between 20011 and today, the relationship has been more random, although since November the SPX has been rising along with rates (green arrows in the chart below). This makes it probable that a further rise in the FED funds rate will not hurt the S&P 500 in the short run.
The bull market continues…for now.
Markets are proxies for Human emotional behavior, just as casinos are, and as such, they tend to reflect sentiment more often than they do fundamentals (although fundamentals always have the last word). Market tops rarely, if ever, coincide with low bull sentiment. Fear and uncertainty are emotions most common in bull markets; bulls climb a wall of worry, while complacency and confidence are the hallmarks of market tops, and the harbingers of bear-market panic. This week, the AAII investor bull-sentiment indicator dropped 7 points down to 30%, and the bear-sentiment jumped 11 to 46%. This level of fear is not how bear markets begin. They begin with bull sentiment above 50%, and bear sentiment below 30% (chart below).
If It's Obvious.....
It is obvious that:
- based on fundamentals, equity valuations are over-stretched.
- coal mining is not going to "make America great again".
- the search for yield has traveled all the way out to the thinnest twigs at the end of the debt-branch which is on the verge of snapping.
- populist politicians are preying on the uneducated by promoting irrationality and pretending as though globalization can be rolled back.
- the FED is going to hike rates in March and that will kill the bull.
The markets are being chased higher despite the 'obvious' reasons not to. A bastardized version of an old market adage applies here: "If it's obvious, it's obviously meaningless".
The market 'climbing a wall of worry', in spite of all the obvious reasons not to, is the same behavior exhibited during the 1994-2000 tech extravaganza. Remember how, despite their obvious lack of worth, revenue-less companies were being valued in the $billions back then?
Recall also, that the tech-rally lasted five years past Greenspan's December 5, 1995 'obvious' comment about "irrational exuberance" in the market (chart below).
No two markets are exactly alike, but Human behavior is constant and it shows up in all markets. Fundamentals will eventually have the last word in this market, but not as long as they are obvious--like they are at the moment. The bull market will likely continue even as rates are being raised.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.