foxex: Fed Whipsaws the Market

Chart Advisor | INVESTOPEDIA

Focus on the Price

By John Jagerson, CFA, CMT

Wednesday, January 09, 2019

1. Fed minutes creates intra-day whipsaw

2. Chinese indexes forming bullish double bottom

3. Are earnings expectations too low?

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Major Moves

The Fed releases its interest rate decisions and the minutes from their meetings on "Fed days" at 2 PM Eastern, and today was the release of the minutes from the meeting in December. Although the minutes aren't used to change the discount rate or the Fed funds target rate, they include additional detail about how the FOMC members are positioning themselves for future rate hikes.

There is an interesting phenomenon on Fed days that plays out consistently over the first 10 to 15 minutes after the announcement and then through the end of the day. After the news is released, the S&P 500 will either spike higher or lower in the first five minutes or so as traders digest the new information. What happens after that initial blip is strangely consistent.

If the market rallies in the first few minutes following the announcement, like it did today, then it is almost certain to erase that spike over the next 30 minutes or less. I have been tracking this since the quantitative easing campaigns began in 2008. This intraday whipsaw occurs a little more than 90% of the time on Fed days. You can see that intraday behavior I have described in the following 5-minute chart of the S&P 500 today.

Further, nearly 70% of the time the market closes in the opposite direction of the initial reaction to the announcement. This means that most of the time, if the initial reaction to the news was a price spike higher, then we would expect the S&P 500 to close down today – which turned out to be a near-miss.

A Bloated Balance Sheet

Besides the potential opportunity for intraday traders, I think this illustrates how much of the market's direction is still dictated by the Fed. The Fed's influence shouldn't be a surprise; even though the economy has improved, most of the money used in the Fed's quantitative easing campaigns is still stuck in the Fed's balance sheet as excess reserves, which means the Fed has a lot of weight to throw around. As you can see in the following chart, there is still more than $1.5 trillion held by the Fed. That balance can shift quickly if the outlook for economic growth changes, which has the potential to spark an extremely volatile market.

For now, the short-term risks of the Fed's balance sheet are probably not a big issue on non-Fed days. However, it's good to use the volatility of days like this to check in on the Fed's balance sheet, the interest rate yield curve, and general market stability just to make sure investors are underestimating risk.

Read more:

What is the FOMC Meeting?

What are Price Whipsaws?
Bank Excess Reserves

Source: finviz.com

Risk Indicators

Despite some of the overhanging risks (flat yield curve, trade disputes, government shutdown, etc.) Investors pushed the market higher today lead by small-caps and high-yield bonds. Today's gains are no doubt partially due to news that ongoing trade negotiations between the US and China are still positive. It seems fairly obvious that the negotiating teams are coordinating their messaging to avoid surprising the market.

There's an argument to be made that if Chinese stock indexes (like the Hang Seng) can break beyond their early December highs then a "double bottom" technical reversal pattern will have completed, which has bullish applications for higher prices. In theory, I agree with that point of view; this will be interesting to watch over the next few days. However, there is also the possibility that traders are "buying the rumor" and will "sell the news" once a deal is actually reached or negotiators proceed to the next level.

Because the underlying economic fundamentals in the US are still very positive, I am biased towards expecting a breakout later this month. However, fragile Chinese stocks could be an effective canary in the coal mine if Chinese stock indexes can't break resistance by the end of the month.

Read more:

What is the Hang Seng Index?

Trading Double Bottoms

Shrinking Profits Could Hurt 2019

Bottom line: Waiting for Earnings

I suspect that much of the uncertainty plaguing the market right now will become a secondary issue once earnings announcements are released from the fourth quarter. The big banks that kick off earnings season like J.P. Morgan (JPM), Citigroup (C), Bank of America (BAC), and others will start releasing their announcements early next week. Expectations have fallen from 15% to 16% profit growth to 11% to 12% over the last 90 days. In my view, if investors have lowered their expectations too much we could see a bullish slingshot send the market higher just as Chinese stock indexes are breaking resistance. If the best case scenario I have laid out materializes, then the first six months of 2019 could contain some of the best profit opportunities we've seen in a year.