Setting Us Up for More 'Fed-Ache'

Investors are disappointed with the central bankers. They are worried that the Federal Reserve’s forecast for four rate hikes in 2016 is too aggressive and want to see that number cut in half, given tepid inflation pressure.

Until the Fed relents, or job growth data weakens significantly enough to give it pause, expect investors to stamp their feet. Every month from now on, you will see a spasm of anxiety about whether the U.S. central bank is going to lift again. It’s going to be an ongoing headache, or “Fed-ache” if you will.

Central bankers in Japan are also under the gun after their announcement late last week of supplemental measures to their existing bond-buying program were met with a collective shrug. They included a maturity extension on government bond purchases and a new ETF purchase program. Yawn. Investors wanted more stimulus.

This echoed the tepid response the European Central Bank recently got to a small extension to its bond-buying program and when combined with the Fed tightening this week, poured some cold water on the true faith of global monetary stimulus.

No wonder markets are so volatile.

The Russell 2000 small caps are down nearly 7% this year, almost back to their August low, while pockets of strength in big-tech stocks like Amazon (AMZN) and Facebook (FB) are all that is preventing the major market averages from joining pretty much every other asset class in the soup.

iShares Transportation (IYT) gapped down Friday and finished at its low for the year, which is a shocker since trucks, trains and planes should be celebrating lower fuel prices.

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Commodities are a fallout zone. Fixed-income is being whomped. About the best thing you can say about iShares Emerging Markets (EEM) is that it has not broken its August-October lows or 2011 lows, as shown above, so perhaps it will bounce on a successful test. Watch that, as it would be a shocker and thus lucrative if it occurs.

Also keep an eye on what’s happening with high-yield corporate bonds, which seems to be the epicenter of this cycle’s speculative excess.

According to Societe Generale’s Albert Edwards, the Fed under chair Janet Yellen “will go down in infamy as deliberately stoking up yet another massive financial bubble. But unlike the start of the last tightening cycle in 2004, this time the corporate bond market is already severely stressed and it may take just a tiny pinprick to burst open the putrid excess.” What a way with words.

The borrowing was largely used to fund stock buybacks, which artificially inflated share prices while leveraging up corporate balance sheets — making them much more sensitive to a slowdown in earnings growth and an increase in credit costs. This is not just bear babble; it’s actually true.

Edwards senses that the Fed’s gradual rate hikes will slowly tighten the noose. “The party’s over and bond investors, who always tend to be more sober types, realize this and have headed for the exits, whereas equity investors are so intoxicated they haven’t realized that the music has stopped. Equity investors are still gyrating around the dance floor — just as in 1999 and 2007.”

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Jason Goepfert of Sundial Capital reports that the action on Dec. 17 and 18 amounted to the first time since 2007 that the S&P 500 has suffered back-to-back 1% losses in the latter half of December. The time before that was in 2000.

Moreover, he reports the market has not suffered back-to-back 1.5% losses in the last half of December since 1937, or any time in December since 1982. Going back to 1928, he notes, back-to-back 1% losses in the last half of December has only happened during bear markets, which is probably an important message.

Even so, the Sundial data shows that buying the second 1% down day and holding until the last day of the year resulted in eight out of eight winners, averaging +3.1%. That’s the positive seasonality that so many are counting on in the last two weeks of the year.

You have to figure some shred of typical seasonality will creep in to drive stocks higher into midweek at least. Historically, 10-day holds starting Dec. 18 are among the top ten-day holds of the calendar, according to data from market technician Ryan Detrick, resulting in a gain of 1.9% on average.

If that does not happen this year, we will know that bears really mean business. Remember that when stocks don’t go up when they have seasonal tailwinds, they tend to perform even worse when the calendar boost fades.

Best wishes,

Jon Markman

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