Rising Fed Funds Rates Do Not Kill Bull Markets

It is easy to get caught up in the belief that the market is being guided by the geopolitical news; possible trade wars, American presidential Tweets (available every day, all-day), military strikes on Syria, and-so-on. But we know that, while the news jostles the market back-and-forth, the news does not drive the market. What drives this market is the Federal Reserve’s monetary policy; a stimulating policy that has caused the stock and bond markets to rage upward for most of the past decade.

The market is now coming to the realization that the Fed is serious about its tightening bias. From the March FOMC minutes :

“All participants agreed that the outlook for the economy beyond the current quarter had strengthened in recent months. In addition, all participants expected inflation on a 12-month basis to move up in coming months… With regard to the medium-term outlook for monetary policy, all participants saw some further firming of the stance of monetary policy as likely to be warranted.”

This does not mean that the bull is dead. It means that we are in the late stages of what has been a tremendous bull market, but which still has some distance to go before it crests — like an aircraft carrier starting to change direction, it is a processes that takes time. Rising rates do not kill markets. In fact, markets rise along with rates…until rates get too high, then the party breaks up.(chart below).

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The two charts that follow, demonstrate how recounting the waves, so that we are in a C3 instead of C4) correction today, fits much better with both the 10-year minus 2-year differential and with the higher average bullish sentiment that accompanied the R4 and R5 rallies in 2000 (charts below).

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The AAII sentiment survey is becoming extremely bearish; bull sentiment dropped -5.8% to 26.1%, while bear sentiment increased +6.1% to 42.8%. It is a bullish signal when bull sentiment is below 50% and bear sentiment is higher than 30% (chart below).

The 8MA of the put-to-call ratio has spiked and is heading back down. This is a strong indication that the SPX will rally (chart below).

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Long term, the technical picture is weakening, but has not raised any warning flags yet. It still supports our view that we are in a late-stage bull market that is correcting, but not collapsing: the MACD has turned around, but has not made a bear cross-over: the RSI has dropped out of the over-bought zone: the stochastics are now out of the over-bought zone and likely to turn around soon: the ADX momentum trend reading is turning down from its extreme level, but notice that from 1998 to 2000, both the trend and the bullish momentum were moving lower while the SPX rallied hard (pink rectangles in the chart below). There are no warning signals unless the 8-month MA moves below the 12-month MA (chart below).

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Even with all the bullish (for gold) geopolitical news, gold has not been able to break out of its trading range. We see this as proof of an underlying weakness in gold which increases the probability that when it does break out of its range, it will do so to the downside.

Technically, gold is slightly negative with the stochastics making a third bear cross-over in as many weeks, and the MACD still looking to roll-over. Add to that, gold’s failed attempt at closing above $1365, and its weakness is underlined (chart below).

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