DEFYING GRAVITY: Financial Markets Floating on Air!
Unfortunately for some beginner investors, a counter-trend bear market rally can look and feel a lot like the start of a new secular bull market. It might be tempting to get drawn into a trade that feels good and seems to make perfect sense as the stock market jolts upward for a short time.
With annualized U.S. inflation barely budging from 8.3% in August to 8.2% in September and Federal Reserve Chairman Jerome Powell telling Americans to brace for “some pain” during his Jackson Hole speech, there’s no reason to believe that the Fed will stop its aggressive interest rate hikes anytime soon.
A 75-basis-point hike in November is practically a foregone conclusion, and another 75-basis-point hike in December is very likely at this point. There’s just no reason to believe that a Fed that is laser-focused on getting inflation down to 2% will suddenly “pivot” back to interest rate cuts this year or early next year.
What most amateur investors don’t pay attention to – but we do, and the central bankers watch it closely – is the Fed’s preferred measure of inflation, known as the “Personal Consumption Expenditures price index.” This rose 6.2% in the year through September, indicating that the problem of high consumer prices hasn’t improved much.
In other words, investors would be irrational to conclude that the Fed will back off of its aggressive course of rate hikes. Yet, the market priced in a massive relief rally during October, sending the Dow Jones Industrial Index of mega-cap stocks 14.4% higher for the strongest October gain since January of 1976.
This might look extremely bullish for the financial markets, but it’s not giving the full picture. Bear in mind that the Dow is only comprised of 30 stocks, and most of them are “safety” stocks like Procter & Gamble, Walmart, Home Depot, Johnson & Johnson, Coca-Cola, and McDonald’s.
Yet, while these are huge companies, they’re not the true leaders of the stock market. The stocks that were the most responsible for the massive bull market since the financial crisis of 2008-2009 are the FAANG stocks: Facebook/Meta Platforms, Apple, Amazon, Netflix, and Google/Alphabet.
For more than a decade, a handful of FAANG stocks carried the weight for the 100-stock NASDAQ and the 500-stock S&P. This was possible because these broad market indices are weighted by market cap, so the FAANG companies are over-represented in terms of index weighting.
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Just recently, the stocks representing Facebook/Meta Platforms, Amazon, and Google/Alphabet had horrific declines after their earnings reports; Apple’s and Netflix’s quarterly results, meanwhile, were mixed at best.
Perhaps the most disappointing quarterly performance was Amazon’s – and that’s a bad sign for the broader economy. If packages aren’t being delivered because inflation-weary customers aren’t placing as many orders, this means the economy isn’t as healthy as the Dow’s recent relief rally would falsely suggest.
When the leaders become the laggards and investors rotate heavily out of growth stocks and into defensive names, this isn’t “bullish conviction.” Rather, it’s a clear sign that the smart money is still bracing for pain in the economy and a continuation of the long-term bear market that’s still in progress.
We’ve witnessed counter-trend rallies and warned our readers about them before on a number of occasions. You may recall the massive head-fake that took place in July and early August, as well as the three-day mini-rally that happened in mid-September.
There was no doubt that the markets would retest the June lows, but unfortunately, many traders got faked out and ended up holding the bag. Right now, the smart-money institutional investors are drawing in a whole new group of bag holders, but you don’t have to be a victim of their rinse-and-repeat strategy.
As always, knowledge is power in the financial markets. When you recognize that the current rally is really just a rotation into safety stocks and that the tech leaders are starting to crack – and the Fed has no intention of backing down in the near future – you can invest with due caution instead of becoming yet another victim.
Chief Editor, CrushTheStreet.com
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