Many years ago the weekly updates of the money supply numbers by the Fed, were anxiously anticipated and analyzed by market watchers as an important factor affecting financial markets. Those days are long gone and money supply numbers hardly ever get any mention by the financial media. When the Fed recently halted reporting M3 monetary aggregates it was only the Wall Street ancients who noticed and objected to the controversial decision.
The most watched event by analysts and investors alike has, for the past two decades, been the monthly meetings of the FMOC. The shifts in monetary policy, signaled by changes in the federal fund rate, and even more so the subsequent release of the minutes from the FOMC meetings released weeks after, have periodically triggered huge market moves. The latest example of an extreme move was the April 18th price spike following the release of the minutes from the FOMC meeting of March 28th when the Fed announced its 15th consecutive quarter point hike in interest rates, to 4.75%.
What got investors fired-up was the part of the minutes where FOMC members had expressed their thoughts that the raising of interest rates was about done, though they remained worried about inflation risks. Some members expressed concerns about the dangers of tightening too much, given the lags in the effects of the monetary policies. Ignoring the usual points and counterpoints in comments on the US economy by the members, the hint that the latest tightening cycle was at its end was all investors wanted to hear.
Though we are close to the peak in short-term interest rates for this cycle, this will not automatically lead to interest rate cuts. A study by Birinyi Associates has shown that during the last nine monetary tightening cycles the market lost, on average, 7% from the time the Fed stopped raising interest rates until the time it made the first cut. Only on two occasions, most notable and fresh in investors memory was the 1995 occasion, when the market gained during these “limbo periods.” The other, a more ominous exception, was the market collapse following the last hike in the federal fund rate, in July 2000.
A month ago the long-term correlation between the bond market and the stock market, after years of decoupling, showed signs of being restored. However, subsequent trading in bonds and stocks suggests that the “illogical” decoupling that prevailed, over the recent eight years, is still very much in evidence. Since 1998, stocks advanced while the intermediate treasuries were declining and vice-versa. A similar correlation exists in the trend of the S&P 500 and the 10-year treasuries.
If all this looks perplexing when attempting to take interest rate changes and their trends as leading variables to the stock market, in fact it is. There simply are no analytical methods or rules that work all the time. In fact, the only “rule of thumb” that seems to work most frequently is that the market will do its utmost to see that as many investors as possible get screwed.
Last week’s rally was more impressive in terms of market averages, most making new multiyear highs, than in terms of internal technical strength. What is most notable is the failure of the NYSE Advance/Decline Line to confirm the recent highs in the NYSE Composite as well as in the other widely watched NYSE price averages. Lagging market breadth as well as pf the Upside/Downside Volume Line suggests a market ripe for a short- term setback.
In contrast to the deterioration in trend-following technical indicators, the contrary indicators measuring investor’s expectations (sentiment) show the lack of bullish exuberance usually accompanying market highs. One good example of this unusual caution on the part of public investors is the ISE Puts/Calls Ratio, the best indicator measuring sentiment of public option punters. A muted bullishness hailing the new market highs is also evident in the latest polling of members of American Association of Individual Investors (AAII). It showed only 33.7% of polled members being bullish. It would be unusual to see a start of a new bear market with public sentiment this half-hearted while the market is at new highs.