Investopedia
Focus on the Price
By John Jagerson, CFA, CMT
Monday, January 07, 2019
1. Rate hike expectations are cratering
2. S&P 500 looking to retrace late-December decline
3. Gauging sentiment with the Russell 2000 vs. S&P 500
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Virtually every analyst on Wall Street agrees that the accommodative monetary policy (low interest rates plus quantitative easing) of the Federal Reserve during the past decade has played a significant role in driving the U.S. stock market higher.
It should come as no surprise then that the Fed’s tightening of monetary policy (raising interest rates plus quantitative tightening) during the past year has caused some concern among analysts. The four interest-rate hikes we saw during 2018 – the first time we have seen that many rate hikes in a single year since 2005 – pushed investor confidence to its limit.
Luckily for the bulls on Wall Street, the Fed has been changing its tune the past few weeks, and traders are rapidly readjusting their expectations. In fact, it appears the market isn’t currently pricing in any rate hikes for 2019.
One month ago, traders had priced in a 34.6% chance (based on the price of Federal Funds futures contracts) that the Fed would have raised rates at least once during 2019. Today, traders are only pricing in a 6.9% chance of the Fed raising rates this year.
Amazingly, the market – at 16.0% – is pricing in a greater chance of the Fed cutting rates in 2019 than it is of the Fed raising rates.
This dramatic reversal of expectations has given traders new permission to buy stocks this year. Lower interest rates make it easier for companies to borrow money for expansion and share buyback programs. They also make earnings yields and dividend yields more competitive when compared with Treasury yields and other bond yields.
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Source: CME FedWatch Tool
S&P 500
The S&P 500 continued its climb today as it rose 0.70% to close at 2,549.69.
Based on my Fibonacci analysis of the index’s latest bearish move that broke through support on December 14, this puts the S&P 500 closing above the 61.8% retracement level for the second trading day in a row. This is a good sign for those who are hoping the stock market will continue to recover in January.
An index, or stock, that experiences a retracement of more than 61.8% has a greater chance of seeing a full 100% retracement, which in this case would mean the S&P 500 climbing all the way back up to ~2,630.
I still think we will need to see the S&P 500 break above ~2,630, and maybe even use that level as support in the future, to confirm the beginning of a potential new bull market, but seeing the index climb this far does instill some confidence heading into earnings season, which begins in earnest next week.
The true test will come in the short term as the S&P 500 approaches 2,630 – which served as a strong support level during November and will likely serve as a strong resistance level in January. If traders can avoid selling into strength at resistance, we’ve got a chance.
Read more:
Fed Funds Futures
What are the differences between the Federal Funds Rate and LIBOR?
Fundamental Analysis Course
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Source: finviz.com
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Risk Indicators
Traders break stocks down into three basic groups: small-cap, mid-cap and large-cap.
Small-cap stocks are typically considered to be the most risky, while large-cap stocks are generally considered to be the most stable and safe. Mid-cap stocks are somewhere in between. I’m going to ignore them for now.
When traders are feeling confident about the future and are willing to take on more risk in the search of greater returns, they will often increase their exposure to small-cap stocks. They do this because small-cap stocks can grow faster (on a percentage basis) than large-cap stocks. It’s much easier to double your revenue when you’re generating $100 million in sales than it is when you’re generating $100 billion in sales.
Conversely, when traders are feeling nervous about the future and are less willing to take on more risk in the hopes of preserving capital, they will often decrease their exposure to small-cap stocks.
You can track trader confidence by creating a relative-strength chart of the Russell 2000 (RUT) – a small-cap stock index – and the S&P 500 (SPX) – a large-cap stock index. When the chart is moving lower, it tells you traders are losing confidence. When the chart is moving higher, it tells you traders are gaining confidence.
Based on the RUT/SPX relative-strength chart, traders started losing confidence in late-June and that confidence has been steadily declining ever since.
Interestingly, beginning in late-December, confidence seems to have turned around and is starting to move higher as the RUT gains strength against the SPX. It still has a long way to go before the relative-strength chart can confirm a completed turnaround, but we’re starting to see some signs of life.
Read more:
What is relative strength?
Buy High And Sell Low With Relative Strength
Investing for Beginners
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Bottom line: Rebounding from Oversold
Wall Street is notorious for allowing the sentiment pendulum to swing widely from overbought to oversold. The climb to all-time highs in September followed by the bearish drop we experienced in December is one more example of this. Traders can’t seem to get enough of dramatic highs and dramatic lows.
I think we’re going to continue to see buying off the recent lows. It’s too early to say if this buying will be strong enough to reverse the trend, but we should continue to see the market move away from its late-December oversold range.
Read more:
How The Sell-Off Wave May Kill The Economic Expansion
Oversold Bounce
What are the best indicators to identify overbought and oversold stocks?
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