The biggest headline of the past week is the Feds decision to raise interest rates Wednesday 15th. Contrary to the widespread consensus that stock prices will initially decline, the markets rallied higher after the FOMC announcement, while gold rallied the dollar fell, and so did the financial sector (NYSEARCA:XLF). Perhaps the strength of the dollar was offset by the rising inflationary pressures, a catalyst that influenced the Feds decision, which would explain gold's rally. Since the Federal Reserve's decisions have such a strong effect on stock prices, it's useful to analyze the economic data they use to make their decisions - employment and inflation. The past week also shed light on such parameters. In a SeekingAlpha article, I recently wrote I talked about the likelihood of rising inflationary pressures and their impact on the raising of interest rates. This week's Consumer Price Index put some of this inflationary induced paranoia at bay, with the rise in prices falling in line with expectations. The Producer Price Index, however, doesn't look so reassuring, up to 0.3% in February, 0.2% more than expected. Energy being the primary source of inflationary pressure while wage pressures have yet to accelerate. My explanation of this staggering difference between the two closely related indexes is lag. As the employment prospects improve (seen in the two most recent Employment Situation reports) the consumer confidence and spending go up. This confidence is seen in Wednesday's Retail Sales report, in Thursday's Bloomberg Consumer Comfort Index, and in Friday's Consumer Sentiment report. The increased consumer spending drives up the costs producers endure (PPI). Businesses, realizing their rising producer prices, will respond by raising their product cost onto the consumer. CPI will rise, and the labor force will begin to demand higher wages - accelerating wage pressures & driving the PPI higher until businesses are more reluctant to hire and more likely to trim their labor force. All of this points to higher inflation and lower employment, putting the Fed in a tough predicament, raise rates to combat inflation or keep them unchanged to encourage future borrowing and spending. This uncertainty will likely be met with declining stock prices as the confidence in the Fed fades.
In last week's article I made four general predictions: markets will decline prior to Fed decision on Wednesday & volatility would be a good play, the Fed will decide to raise interest rates, the markets would dip as a result but then rally by the end of week, and gold will outperform by the end of the month. Overall, these predictions were right, but not entirely. I predicted volatility (^VIX & UVXY) would be up during the first two days; I was right in ^VIX being up, but not UVXY. The Fed did raise interest rates, but the stock market skipped the dip and went straight to rally mode. Gold followed suit, rallied on Wednesday at 2:00 PM, JNUG gaining 36% that day. So overall I would say I predicted the general market trend.
"Money is made sitting, not trading" - Jesse Livermore
Mental Exercise Questions:
• Why do you think financial fell and the markets rallied post-Fed decision?
• Which direction will the stock market go this week?
• Which sector performed the best this past week?
Monday 20th: Chicago Fed National Activity Index
Wednesday 22nd: FHFA House Price Index, Existing Home Sales
Thursday 23rd: Yellen speaks, New Home Sales
Friday 24th: Durable Goods Orders
My Market Prognosis:
I noticed something interesting this past week. On Wednesday after the Fed raised interest rates the market rallied initially, yet it posted losses on Thursday and Friday. This weakness in the market following Wednesday's bullish rally leads me to believe that the markets will take a breather and retreat from their highs. Compared to last week, this week will reveal less pivotal economic data. The lack of direction and insight may leave investors uncertain and cautious. I think that the first couple of trading days will be sloppy with stock prices either neutral or mildly declining. Investors will look for clues about the Feds prospects during Yellen's speech on Thursday. I expect her speech to communicate a positive depiction of the state of the economy, pushing stock prices slightly higher. As I wrote in my Inflation article in February, new stock highs will be met with greater levels of resistance, making it harder to continue pushing higher. This stagnation could turn into a minor sell off as investors get itchy feet. This development doesn't have to necessarily occur this week or the next; I just see a slight sell off as a probability if stock prices remain stagnant and if there is a lack of insightful economic data. One key behavioral cue I will be looking for is how investors are hedging themselves; are they selling their positions or are they longing volatility? I think that before deciding to sell any of their positions investors will purchase protection by betting on volatility, but if everyone is longing ^VIX and no one is actually selling their positions, the market shouldn't be all that volatile, it will be stagnant instead. Given such conditions, any significant volume signaling selling will feed onto itself until stocks sell off.
I think gold will continue to perform well. If people panic & the market has a minor sell off, people may buy gold for protection. Any economic data that suggests rising inflation will also drive the price of gold up.
1. Markets will be mostly flat this week, possibly lower in the first couple days of trading
2. Gold will outperform this week
3. Overall market will be stagnant
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in JNUG, JDST, UVXY over the next 72 hours.