In the "Fed Pulls the Punchbowl" part 1, I discussed some of the liquidity shifts we've seen in the credit markets over the last year or so. Since then, we've seen the market fall 3,000 points from ~24,500 to ~21,500 only to bounce back in the middle of this zone with the 1,000 point up day on Wednesday the 26th. Volatility indeed.
The following chart shows the reduction in liquidity dynamics as they have progressed. The most important point is that monetary policy operates with a lag (something many forget when markets are trending higher). I half jokingly called this chart "how to kill the stock market in 4 easy steps".
The damage has not been immaterial. Before last week's bounce, markets were down at levels rivaling the '87 crash, although obviously over a longer time frame. Bears finally got their "crash", unfortunately it was a year after most predicted (see my 2017 article and market call: 'The Melt Up')
We also saw the put/call ratio spike last week, something many have been buzzing about. I put together this chart to remind participants that sometimes contrarian indicators are consensus, in that someone might know something you don't. There really is no way around this.
Fed in a Box
The bigger, more fundamental issue which we all know is that the Fed is in a box. This is something I and many others have been commenting on for a long time. This chart is from over year ago, when Yellen was still the chair, but if anything, this situation has only worsened (evidenced by the latest change in policy vs. impacts to stocks). The key point is to see how policy remains tepid, in either direction as they fight between asset market speculation and negatively impacting the real economy too much.
I've been fairly critical of the Fed here, not because I am a proponent of easy money (far from it), but at this stage, I am cognizant of the likelihood of something breaking again.
Here's a chart from October inside of the updated look at commodities. I have been mentioning the weakness here for some time. Note this is also why I incorporate macro data into my overall approach. Markets and equities price off many factors, including overall inflation/deflation and Fed policy risk. It will be very interesting to see how the Fed navigates any further declines here.
It was also the above understanding (impacts of liquidity on commodities) that helped me warn members to avoid chasing, and selling energy and the related stocks as it surged into resistance.
But of course, the bigger question is, what now? With that in mind, here are some of the changes in the financial markets since the Fed moved in December and equity has dropped. First is the rate hike vs. cut odds for January 2020. Interestingly, the market now is looking for a cut over a hike by the start of 2020. Again, this just amplifies the Fed box we know about, but also speaks to an attempt to support markets.
Policy: Rate Cuts
Technicals: 200 WMA
Another big area now being discussed is the 200-week moving average. While most 'chart' watchers have been obliterated through the volatility and focusing on the daily charts, I've been adamant for a year that we would likely visit the 200-week moving average. This is because it tends to happen every 3 years or so, even during big up cycles. We also saw 60% bulls as the year began, something that has only happened 2 times since 2009 (2010 prior debt downgrade, 2014 post Ebola, prior to '15-'16 correction - you can see video excerpts here "Cash outperforms, Oil Crashes")
Both instances saw a test of the 200 week in the following 18 months. Behaviorally, this makes sense as 60% bulls exhaust all potential longs and generally suggests dumb money has bought the highs.
For bulls, the following chart is really one of the larger keys (alongside Fed policy, earnings, valuations, market breadth, intra-market, etc.) to if the cycle stays intact.
In my members area, I focus on this at least once a month, and discuss the components beyond price that we need to watch for with respect to where we are in the cycle.
Riding trends is relatively easy. There's an old adage, don't confuse brains with a bull market. It's fair to say we've seen that in stocks like Nvidia (NVDA), Netflix (NFLX) and so on as the Fed pulled the punchbowl (see my articles 'The Nvidia Dump' and 'The Netflix Dump'). Going forward, I will continue to look to Fed policy, changes in asset prices and intra-market, credit markets, and overall valuations for the next opportunities.
Thanks for reading...
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.