'Buy the Dip' Is No More
What to expect from the Federal Reserve next week... Is the Fed getting 'dovish?'... A change of character for the market... 'Buy the dip' is no more...
The Federal Reserve will hold its December rate-setting meeting next week...
And for several months now, the expectations have been relatively clear: The Fed would raise short-term interest rates again this month – marking its fourth increase this year – followed by another three to four hikes in 2019.
But recently this has changed. The ongoing stock market decline – along with some perceived "dovish" comments from some Fed officials – has cast doubt on this forecast.
While the market still expects a rate-hike next week, interest-rate futures imply the probability of such a move has fallen from nearly 100% following the Fed's September meeting to less than 75% today.
In other words, the market now believes there's a better-than-one-in-four chance the Fed won't raise rates this month. And expectations for next year have fallen even further, with some even betting the Fed could begin to cut rates again. As news service Reuters reported yesterday...
The Federal Reserve's plans to continue raising interest rates next year were met with more skepticism on Wall Street on Monday, with futures traders betting on a pause...
Traders of short-term U.S. interest-rate futures are, for their part, betting the Fed may halt its rate hikes altogether next year, and could even move to cut borrowing costs...
Based on prices of Fed fund futures, traders now see a 73% chance of a rate hike next week, and just a 49 percent chance of a further rate hike by the end of next year. Contracts expiring in June 2020 are now fetching a higher price than contracts expiring a year earlier, meaning traders are beginning to put some money on a rate cut.
We don't expect any major surprises from the Fed next week...
But it is beginning to look more and more likely the central bank may end its "tightening" cycle earlier than expected.
However, we'd caution you from getting too excited about this prospect. After all, it would be a de facto admission by the Fed that it had made a mistake and that the economy was not as strong as it believed.
In addition, history suggests Fed policy reversals are typically not a bullish sign for stocks or the economy. And this one would be occurring at the lowest peak in interest rates in history, suggesting the fallout could be worse than ever.
Meanwhile, we're seeing another worrisome sign for stocks...
In short, for the first time in decades, investors are suddenly hesitating to "buy the dip." As the Wall Street Journal reported over the weekend...
An investor trend that has helped buoy stocks over most of the past decade is showing signs of breaking down.
For the first time since the dot-com era, investors are cautious about buying shares after selloffs, raising signals that the longest bull market in U.S. history is in its late stages.
Going back to the 1980s, the S&P 500 has typically rebounded after posting a weekly loss, such as the punishing setback it suffered last week. This year, that "buy-the-dip" trend has broken apart. The broad index has fallen an average of 0.04 percentage point on the day following weekly declines, marking the first time since 2002 that stocks have consistently slipped after one-week pullbacks, according to Morgan Stanley.
Incredibly, this didn't occur even during the worst of the financial crisis in 2008 or 2009.
In fact, according to the Journal, there have only been six other years since 1980 that have experienced a similar trend.
All six of them occurred at the start of or in the middle of a bear market. And three of them – 1982, 1990, and 2002 – also coincided with a recession.
Now, as always, we don't recommend giving too much weight to any single data point, study, or indicator...
This change of character doesn't necessarily mean the bull market is over or that a recession is imminent. But it is notable. And along with the other potential warnings signs we've been following – including continued weakness in our proprietary Complacency Indicator, early signs of credit market stress, and the erratic price action of the major market indexes, among others – it's one more reason to remain cautious today.
Whether or not the long bull market resumes, we at the Digest believe the risk of a continued correction remains high. For now, our advice remains the same: Stay long, but stay "hedged"... And keep a close eye on your trailing stops, just in case.
New 52-week highs (as of 12/10/18): MarketAxess (MKTX).
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December 11, 2018