This Week, It’s All About The Fed…
Last week’s market action was relatively dull. And by dull, I mean there wasn’t much price volatility.
Now, just because the market was “dull” doesn’t mean it wasn’t also interesting. Dull markets actually provide us with important information about what’s likely to happen next…
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The dullness resulted from the fact that the S&P 500 was almost unchanged after Tuesday. I’ve created a chart showing the last two times we saw a market that was this dull. The blue rectangles highlight the “dull” periods.
The bars at the bottom show the true range of each day’s market action. The range is the difference between the high and the low. This indicator misses the market action on days when the price gaps up or down at the open. (Gaps are opening prices significantly above or below the previous day’s close.) The true range corrects for that problem by including the value of the gaps. That makes it a more accurate reflection of volatility.
Low volatility is important because it is often followed by high volatility. The last two times we saw volatility this low, the S&P 500 sold off. In March, the Index dropped 3.5% in one week. In May, the selloff was deeper, covering 7.6% in four weeks.
I highlighted those two periods because looking backward can help us understand what is likely to happen in the future. Based on the current conditions, history suggests we are almost certain to see increased volatility in the next few days. That’s what the chart tells us, and that’s confirmed by the news.
The Big Meeting
On Tuesday, the Federal Reserve began a two-day meeting. On Wednesday afternoon, Fed Chairman Jerome Powell will hold a press conference.
#-ad_banner-#These press conferences are relatively new, dating back to March 2011 when Ben Bernanke began the practice. Since then, every three months, the chair has provided an update on the Fed’s policy. It’s an attempt to increase transparency so the Fed doesn’t surprise the market.
Press conferences held by Bernanke and his immediate successor Janet Yellen were generally uneventful. Powell’s comments have been met with volatility almost every time.
His first press conference in March 2018 led to a 5.8% decline in seven days. His June press conference led to a two-week, 3.6% decline. There was one press conference that led to a small rally, a 1.7% gain in September 2018. But in December 2018, Powell’s press conference sparked a 7.8% decline over five days.
This year, the S&P 500 rallied 3.4% over the four days after his comments in January. And in March, the S&P 500 sold off 2.5% over three days.
On Wednesday, Powell will hold his seventh press conference knowing that four of the past six ignited selloffs. Traders are also aware of this. They will be watching closely, and we should expect a significant market move starting on Wednesday.
Volatility indicators point to a potential decline. But, as with other Powell-induced market moves, this would most likely be a buying opportunity.
That’s confirmed by stochastics, a popular momentum indicator shown in the next chart.
Stochastics completed a “buy” signal earlier this month. The signal came while the value of the indicator was above 40. We have to go back to August 2010 to find a similar signal.
What makes this signal so unusual is that stochastics usually gives “buy” signals after becoming oversold. In this case, traders rushed in to buy on the first signs of weakness. That signal confirms my observation in my previous commentaries that there are trillions of dollars in cash sitting on the sidelines, waiting for a buying opportunity.
Sentiment continues to show there is significant buying power on the sidelines. The most recent American Association of Individual Investors (AAII) survey shows just 26.8% of respondents expect gains in the next six months. Many of the bears moved to the neutral camp in the latest survey, showing they refuse to believe the stock market can continue to rally.
Sentiment is a contrary indicator, and with the majority believing the market is unlikely to rise in the next six months, the stock market is actually likely to rise. I expect that gain to begin in days, after Powell speaks on Wednesday.
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