We are two days away from what could be the single-most important Fed meeting there’s been in years. If Fed Chair Powell sticks to the script and gives the market what it expects, it is likely that stock prices will make an explosive move higher.
On the flipside, if Powell deviates and does the unexpected, well, I expect there will still be explosions – but they will not be good ones.
Now, in order to put all this in perspective and define what’s at stake, let me backtrack a little bit and have a look at the steep declines the market experienced last week…
It was not a good week for stocks. It started bad with heavy selling that took the S&P 500 from 4,071 to 3,941 on Monday and Tuesday.
Now, after a bout of heavy selling like that, it’s never a surprise to get a little relief. And the S&P 500 managed a slight recovery mid-week up to 3,963. But the selling resumed on Friday after a worse-than-expected read on November inflation from Thursday’s Producer Price Index (PPI).
For those that may not know, the PPI measures how much the companies that make stuff are paying for the materials they need to make stuff. In other words, it measures inflation at the company level, the assumption being that higher prices at that level will be passed on to the consumer, which is then measured by the Consumer Price Index (CPI).
For whatever reason, the market was expecting a significant decline from the November PPI. It didn’t happen. Yes, November PPI did come in lower than October’s, but not nearly as much as the market expected. And that’s why stocks ended the week on a pretty negative note.
Now let’s take a closer look at the recent action for the S&P 500…
Back to the Bear Market?
The declines on Monday and Tuesday took the S&P 500 back below its 200-day moving average (MA). The 200-day MA is important because it is generally considered to be the long-term trendline. If the S&P 500 is above the 200-day MA, then we’re in a bull market uptrend. If the S&P 500 is below it, then the trend is lower.
So that move could be construed to be a pretty negative development – a resumption of the downtrend.
The S&P 500 had just moved above that 200-day MA on November 30, for the first time since May. So sure, there may have been some minor celebrations that stocks were showing some strength. Still, I told you at the time that I didn’t expect stocks to move higher from those levels, and they didn’t…
But the failure to hold above the 200-day MA is not a complete disaster. And I’ll tell you why…
Friday’s decline brought the S&P 500 down to 3934, where it closed for the week. But that was not the low for the week. The low for last week came during Tuesday’s selling crescendo, at 3,918, right at a significant support point at 3,920. And that 3,920 support point did its job: it held.
So now, there are three main things to consider as the S&P 500 sits just a bit above that 3,920 support.
One is tomorrow’s release of the November Consumer Price Index (CPI). The second is the Fed’s FOMC meeting that concludes on Wednesday with a new interest rate hike. And the third is the technical picture that we’ve just discussed …
Reading the Tea Leaves
Tomorrow’s CPI is expected to show a small decline, not nearly as dramatic as the drop that was expected from last week’s PPI.
I’ve heard it said that expectations are just predetermined disappointments. And so I consider lower expectations for tomorrow’s CPI report to be a good thing. Because it suggests that even if the CPI comes in worse than expected, it won’t be significantly worse than expected. And that matters.
It’s always about expectations in the stock market. Whether it’s earnings or economic data, so long as it’s in the ballpark, investors can say “that’s about what I was expecting, I was ready for that.”
So, I hate to be dismissive of an important economic report, but again, I don’t think tomorrow’s CPI number will be a market-moving event.
Which brings us to the Fed on Wednesday…
As we all know, the Fed has been hammering the economy with 75 basis point interest rate hikes. The most obvious result of these hikes can be seen in mortgage rates. A year ago, you could get a loan for 3%. Today, that same mortgage is close to 8%. If your monthly payment was $1,000 at 3%, it’s over $1,500 on a loan at 7.5%. Basically unaffordable for the vast majority of American families. And the point is, the Fed’s rate hikes are affecting the U.S. economy in significant ways.
The main reason that stocks started a rally back in October that culminated in that brief move over the 200-day MA on November 30th is that investors were looking for the Fed to slow the pace of rate hikes as we near the end of the rate hike campaign.
Right now the Fed is expected to deliver a 50 basis point hike on Wednesday, followed by two 25 basis point hikes early next year. So, 50 being lower than 75, and 25 being lower still, it appears the market is getting what it wants. The pace of rate hikes is slowing. And after Wednesday, with expectations for just two more small rate hikes early next year, the end of the rate hikes really is in sight.
Of course, the question here is: will the Fed stick to the script on Wednesday?
The S&P 500 has already held support at 3,920. If the Fed gives the market what it expects, a 50 basis point hike, many investors will assume that 3,920 is a solid bottom and buyers will swarm into the stock market.
BUT – if the Fed deviates from the script on Wednesday – like, say it delivers a 75 point hike and then suggests more than the two 25 point hikes investors are looking for early next year – will that’ll be a whole new can of worms. I would expect the S&P 500 to slice through that 3,920 support and make a beeline for its 50-day moving average at 3,850 (roughly 100 points lower than current levels).
So sit tight, keep an eye on 3,920 and we’ll see what the Fed says on Wednesday.
Take care and I’ll talk to you soon,