Whatever Will the Fed Think of Next?

Wednesday, 16th September, 2015
Melbourne, Australia
By Kris Sayce

  • More volatility
  • Could a recession be ‘good’ news?
  • Odds rise
  • Doing it in eighths
  • Scalping cash

The volatility continues.

In a moment, I’ll show you a chart of the S&P/ASX 200 index going back over the past month.

You’ll see that the market is in a clear range. Investors are waiting on two key events: an interest rate decision from the US Federal Reserve this Friday morning Australian time, and more clues on whether the Aussie economy will go into recession.

More on that in a moment. First…

More volatility

Overnight, the US Dow Jones Industrial Average closed up 228 points, or 1.4%.

In Europe, the FTSE 100 index ended the day 0.9% higher.

Meanwhile, oil is still trading just below US$50 per barrel, and gold is just about holding above US$1,100 per ounce.

As for the Aussie dollar, for now it appears to have settled above 71 US cents. But that could change. The market still appears to be convinced that the Fed won’t raise interest rates on Friday morning.

Although, as I’ll show shortly, investors aren’t quite as convinced as they were just a few days ago.

Could a recession be ‘good’ news?

Before we get onto that, here’s the chart I mentioned before. It’s of the Aussie S&P/ASX 200 over the past month.

That’s what I call volatility…

Source: Bloomberg

During the period of this chart (one month) the Aussie market has traded in a 400 point range.

That’s a pretty big range. It shows the fear and uncertainty in the market.

Investors don’t know if they should buy or sell.

Is a US interest rate rise positive or negative for the market? Likewise, if the Fed doesn’t increase rates — should the market be sad or happy about it?

The same goes for an Aussie recession.

Of course, a recession isn’t in itself a positive event (except for the fact that it purges the market of bad investments). But, confirmation of a recession could actually boost stock prices.

It may sound crazy, but there’s an argument to say that investors have already factored a recession into the prices they’ll pay for stocks.

If Australia goes into an official recession, investors may start thinking about how long it will last and which industries and companies will benefit when the recession ends.

It’s a theory. But I wouldn’t bet on it just yet. It’s almost impossible to know in advance just how much of the bad news investors have already priced into the market.

The following chart shows you what I mean. It’s of the US S&P 500 index from the start of 2000 through to the end of 2003. The red shaded area covers the official period that the US economy was in recession:

Source: Bloomberg

This period also covers the dotcom crash, and the September 11 terrorist attacks.

As you can see, not long after the US economy officially entered recession, the market rebounded…only to slump again leading into the terrorist attacks, before rebounding and then finally trending down to the low points in October 2002 and March 2003.

The point I’m making is that the response of the markets to a recession really depends on the time period.

If you short-sold the market in March 2001, hoping for huge gains, you would likely be disappointed as the market rallied through April and May.

Likewise, if you bought the market then, believing the worst was over, you would be feeling pretty sore two years later as the markets finally bottomed.

Odds rise

So, what will the Fed do?

Earlier this week, according to Fed Funds Rate futures contracts, there was only a 28% probability of the Fed raising rates.

Today, the probability is 32%. It’s not a big move.

Source: Bloomberg

But it does suggest that perhaps those folks holding bonds are using Fed Funds Rate futures contracts to hedge some of their exposure.

And it also plays into the view of the firm that’s the breeding ground of future prime ministers (yes, you Mr Turnbull), Goldman Sachs. As Bloomberg reports:

Goldman Sachs Group Inc. says financial markets are vulnerable because nobody can agree on what the Federal Reserve will do. Treasuries whipped around amid the debate.

U.S. government securities rose, rebounding from a rout Tuesday when retail sales data increased speculation the Fed will raise interest rates this week. Goldman Sachs Chief Economist Jan Hatzius said it probably won’t happen until December, or maybe even in 2016. The lack of consensus is reason for policy makers to hold off when it finishes its meeting Thursday, he said.

“There will be some concern that the market’s not prepared,” Hatzius said in an interview Tuesday with Bloomberg. “There’s a risk of an adverse market reaction.”

Interest rates are low. Everyone knows that. But don’t let the low rate fool you. Here’s the chart that most folks look at when they talk about the long term bear market for bond yields (inversely, a bull market for bond prices):

Source: Bloomberg

It’s pretty amazing to see just how the trend has developed. The chart above, starts in 1977, peaks in 1981, and then trends lower over the next 30-plus years.

But look at the right-hand side of the chart. It’s almost impossible to see. And yet, you can see it. You can see a new trend in bond yields. And this trend is going higher. You can see this in close-up on the next chart:

Source: Bloomberg

The left-hand side of the chart is the period from 2008 through to 2011, as the new era of money printing took hold. The middle section of the chart covers the peak of the money printing cycle, and the right-hand side of the chart (marked by the red trend line) shows the period from 2013 when investors started to really think about rising interest rates.

On the long term chart, the rise in interest rates doesn’t seem that significant. But on the short term chart, you can see that something is brewing.

It’s the expectation by investors that one day (perhaps as soon as this Friday morning Australian time) the Fed will begin to raise interest rates.

If you’ve seen my report on this here, rising interest rates was one of the warning signs I outlined more than a month ago, when I predicted the current volatility and crashing markets.

Today I believe, as I did then, that the Fed is determined to raise interest rates as soon as it can. The main purpose is to engineer a severe stock market crash.

The reason for that is to give the Fed an excuse to begin another round of money printing. Because if you haven’t figured it out by now, money printing is the only way the Fed can now artificially stimulate the economy.

The Fed knows that even increasing interest rates by a fraction of a percentage point will have a major effect on the market.

But it’s prepared to do one small increase in order to achieve the desired effect of crashing the markets. You can find out more about that here, including the ‘crash protection’ stocks that investors can buy to hedge a portfolio against a collapse in stock prices.

Doing it in eighths

Here’s another option. According to Bloomberg:

There’s a more palatable option for those investors too wimpy to stomach the quarter point increase in interest rates from the Federal Reserve that may come this week: a 12.5 basis point shift.

In other words, rather than raising by quarter percentage point increments, the Fed could raise by one-eighths of a percent.

Sheeesh! Whatever next?

Scalping cash

The ‘cash scalpers’ are at it again today…

  • One investor legally ‘scalped’ $2,700 today from Westpac Banking Corporation [ASX:WBC], without buying or selling a single share.
  • Another investor ‘scalped’ $714 from Woolworths Ltd [ASX:WOW], without buying or selling a single share.
  • And another investor ‘scalped’ $792.50 from Woodside Petroleum Ltd [ASX:WPL], completely legally, and without buying or selling a single share.

There are investors ‘scalping’ the market every day, cashing in small cash amounts like those above.

For those in the know, it can be a lucrative way to accrue extra cash income from the market — without necessarily buying and selling stocks.

If this all sounds confusing, don’t worry. I’ll explain everything soon.

Cheers,
Kris+

……………………………………………………………………………………………………………………….


End of day market data

We’re now including a few snapshots of market data in Port Phillip Insider. So far, the feedback has been 100% positive. But keep sending in your feedback. We’ll keep coming up with ideas of what to include, but it would also be great to know what you’d like to see too. If we can accommodate that, we will.

Drop us a line at letters@portphillipinsider.com.au, and type ‘Market data’ in the subject line.

52-week highs: 15 stocks, including Diversa Ltd [ASX:DVA], Pacific Brands Ltd [ASX:PBG], and SMS Management & Technology Ltd [ASX:SMX].

52-week lows: 26 stocks, including Beach Energy Ltd [ASX:BPT], Monadelphous Group Ltd [ASX:MND], Seek Ltd [ASX:SEK], and Woolworths Ltd [ASX:WOW].

Selected Market PE Ratios: the price to earnings ratio for selected indices based on the total market capitalisation and earnings of the stocks within the index.

S&P/ASX 200 — 18.54x

Dow Jones Industrial Average — 14.50x

S&P 500 — 17.46x

FTSE 100 — 22.33x

Shanghai Composite — 15.04x

Selected Market Dividend Yields: the dividend yield for selected indices based on total dividends paid out by each stock within the index.

S&P/ASX 200 — 5.18%

Dow Jones Industrial Average — 2.58%

S&P 500 — 2.18%

FTSE 100 — 4.25%

Shanghai Composite — 2.09%

Advances/Declines: the number of stocks that are up or down compared to the previous day’s closing price.

S&P/ASX 200 — 152 advances/41 declines

S&P 500 — 455 advances/45 declines

FTSE 100 — 69 advances/31 declines

Nikkei 225 — 155 advances/65 declines

Shanghai Composite — 833 advances/128 declines

Volatility: the VIX reflects the estimated volatility of an index derived from the prices of call and put options on the respective index.

S&P 500 VIX — 22.54 (52 week high/low: 53.29/10.88)

S&P/ASX 200 VIX — 24.53 (52 week high/low: 33.26/11.57)

CBOE Oil ETF VIX Index — 51.14 (52 week high/low: 74.29/18.21)

Year-to-date: the performance of various indices from the start of the year through to today.

S&P/ASX 200 — -5.77%

Dow Jones Industrial Average — -6.86%

S&P 500 — -3.92%

FTSE 100 — -6.53%

Shanghai Composite — -6.66%

FX and Commodities: selected foreign exchange and commodities prices (all prices in US dollars).

Gold — $1,105.24 per troy ounce

Silver — $14.39 per troy ounce

Iron Ore — $57.28 per tonne

WTI Oil — $44.89 per barrel

AUD/USD — $0.7143