Navigating the markets as traders is a huge challenge as none of us can know for sure what will happen in the future. However, if we pay attention to the signals, we will have a good understanding of where things are going. At the moment it looks like they’re heading in a bearish direction.
The stock market is an efficient discounting machine. While not perfect, it can tell us where the economy is going – most of the time.
Market tales predicted strong economic growth in 2020, and the stock market reflected that positive sentiment. When it was found that the economy was facing dire consequences from the COVID-19 pandemic, the stock market fell hard, setting a record for the sharpest crash.
Economic conditions changed quickly as the Fed added liquidity to the markets and Congress passed a stimulus package that put cash into the hands of the public. As a result, the stock market hit an all-time high for months. That could end now.
Why the markets look bearish
Last week, Fed chair Jerome Powell made a very Hawkish statement on inflation. The last time he was hawkish – December 2018 – markets were bombed. The late Santa Claus rally (barely) saved the day and on January 4, 2019 Powell changed his mind. After that speech, the markets recovered throughout the year and continuously hit new highs.
But now we’re early 2021 and at a crossroads. The message from the markets now is one of caution and care. With most of the 2021 gains now wiped out (with the exception of the Russell 2K), it’s time for a reevaluation.
The rise in interest rates isn’t all that unexpected, but the speed at which it has happened is somewhat worrying for everyone, including central bankers. Chairman Powell and other Fed officials recognized this. With prices soaring and a much stronger economy, it stands to reason that inflation is starting to rise. Is that a problem for the Fed? Probably not right now, but you need to be vigilant.
When interest rates rise due to rising inflation expectations, stocks don’t do well. The Nasdaq is in the middle of a major correction and other indices are closely behind.
The Fed’s stimulus policy has two elements: zero interest rates and direct bond purchases. The latter will slow down at some point before the former sees interest rates rise. The bond market is pushing the Fed to see what they see. Are you right? We’ll find out soon, but the bond market is hardly ever wrong.