FED Watchers’ Confusion, and Counter-Trend Sentiment Indicators
It is becoming increasingly evident that the FED’s rate hike was based more on ego than on need. They spent the entire 2015 year painting a recovery scenario for the economy, that had the effect of hammering the SP 500 into a flat line. When they finally decided that a 5% unemployment rate would provide enough cover, they force-fed (no pun intended) the market a 0.25% rate hike that resulted in panicked vomiting of equity assets. Now some of the FED egos are starting to hedge their actions.
Take for example, Fed Governor Brainard (FOMC-voter) who stated this week that certain headwinds mean Fed funds will take a slower path than expected, and that monetary policy among major nations may not end up differing from that of the FED. Since other major nations are not raising rates, but rather continuing their stimulus policies, he must be saying that the FED will not continue raising rates. Only two months ago, the FED was singing a very different tune.
Fed Governor Powell (FOMC voter) made some vague remarks about confusion for FED watchers as a result of “time-based and data-dependent guidance”, but said nothing about the effect of the recent market turmoil. Despite these comments, the CME FED tool shows an increase in the probability of a quarter-point rate hike in March, from 2% last week, to 12.4% this week.
If the FED’s rate hike was meant to either, boost confidence in the economy, or send the signal that the FED had succeeded in saving America, it has failed on both counts. Inflation (one of the two FED mandates) was not even close to the 2 percent target, and wage increases (the most effective booster of the economy, as far as ANG Traders is concerned) were tiny, which of course caused confusion for FED watchers. This confusion will continue to feed market volatility.
Ever since the beginning of 2016, our Price Modelling System has never quite made it into negative territory, even though the price-drop in the SP 500 has been significant. We have been studying both the fundamentals of the economy, and the psychological (sentiment) aspect of the market in order to either back-up our Model’s readings, or to disregard its readings. So far, everything we have looked at seems to agree with our Model’s reading of the future price of the market; this is a painful correction, but not the start of a 2007–2008-style collapse.
In the graph above, the vertical blue lines highlight the correspondence of minima in the SP 500 with minima in both bullish assets and bullish sentiment, and maxima in bearish sentiment. This is what we have been pointing out for the last two months, but what we have not written about is the counter-trend of these sentiment indicators just before the 2008 bear market.
The green vertical line indicates the top of the SP 500 in 2007. Notice that even though this was a maximum (top) in the SPX, the bear sentiment was high and the bull sentiment was low (green circles), which is counter to what usually happens at the top of the market.
A few months later after a 300-point drop (red vertical line), the sentiment indicators again went counter-trend and behaved like they usually do at market tops; low bearish sentiment, and high bullish sentiment (pink circles).
In 2008, even though we had just had a 20 percent drop in the SPX, investors were highly optimistic about the future price of the market, something that does not happen at market bottoms. These two readings, which ran counter to the probabilities we had established for tops and bottoms, allowed ANG Traders to miss the subsequent 600-point loss of 2008. The situation at this time is NOT counter-trend, and continues to read like at least a local bottom.
The balance of probabilities remains on the side of ‘nasty correction, but not a bear market.’