Written by: Rafael Zorabedian
Is the Fed moving too quickly? Can the equity markets handle a Fed taper without the tantrum? What about inflation? Yesterday’s FOMC statement creates more questions than answers.
So, we now know that the Fed expects to hike interest rates in 2023.
That could be ok. However, there was some contradictory language yesterday surrounding inflation. Is it transitory in the eyes of the Fed, or is it something more? Yesterday’s press conference seemed to play both sides of this coin, and stocks sold off on the uncertainty.
That’s ok too.
In reality, the selloff wasn’t too bad, with the $SPX losing 0.54%; and the $VIX rising by 6.64% on Wednesday. The benchmark 10-year yield $TNX tacked on 4.67% and finished yesterday’s session at a 1.568% yield. There was a pocket of strength in financial names and a few select market sectors. However, it makes me wonder, will asset managers be taking a different view on equities going forward? 2023 is a long time from now, but the idea of the punch bowl being taken away combined with an uncertain inflationary environment could paint a different picture going forward. We just don’t know yet.
Fortunately, some of the ETFs that we have been following fared well on Wednesday. Strength surfaced in solar and green names, which shows that we are on the right path, as capital had to make its way into something other than cash, financials, and volatility yesterday.
Figure 1 - SPDR S&P 500 ETF February 17, 2021 - June 16, 2021, Daily Source stockcharts.com
So, even though it seemed like the sky was falling if you were watching business news coverage after the Fed statement, it was just a pedestrian down day on decent down volume. For SPY traders that have been waiting for a pullback, there could be an opportunity in the cards soon; if we get some follow-through selling. However, I personally favor the IWM at this time, as discussed thoroughly in the May 27th publication.
Turning bearish of an event like today usually turns out to be the wrong move, in my experience. So what, rates will go up in 2023. They have to go up at some point; there is plenty of warning and plenty of time between now and then. Buying the pullback would still be the prudent move based on probabilities (it is still a bull market).
Speaking of the IWM , it fared better than the SPY in Tuesday’s session, giving up only 0.21%. It could be due to the reconstitution theme that we have been discussing.
Figure 2 - iShares Russell 2000 ETF December 29, 2020 - June 16, 2021, Daily Candles Source stockcharts.com
That is a pretty healthy daily candle for the type of session that the major indices experienced on Wednesday.
So, keeping the above in mind, is it really prudent to suddenly get bearish on the indices based on the Fed guidance towards rate hikes in 2023? Probably not. At least not today, anyway. Bull markets like this don’t just go out with a whimper on most occasions. Let’s see how things transpire across the major indices once the new Fed guidance is digested by market participants.
Now, for more bearish folks, I’d like to turn our attention to the IWM/SPY ratio that we discussed in our May 27th publication surrounding the Russell 2000 reconstitution trade.
Figure 3 - IWM iShares Russell 2000 ETF / SPY S&P 500 ETF Ratio August 27, 2020 - May 26, 2021. Source tradingview.com
While the spread hasn’t moved too much to the upside since May 26th, it has tacked on a penny, moving from 0.53 to 0.54. Percentage-wise, there is nothing wrong with that, and this is a theme that could continue to work through June 28th. This trade is long the IWM and short the SPY .
While it may be too early to tell how the broader markets will react to the Fed’s change in stance, it is also not necessarily a time to make rash decisions. Looking for pullbacks when more emotional traders decide to short the market could be a good idea. For now, we will see how Asia and Europe digest the message of the Fed in the overnight session followed by another US trading session. Time will give us more clues regarding the market’s interpretation of the Fed.
Now, for our premium subscribers, let's look at what was working, even in yesterday’s down session ( a few of the ETFs we have been analyzing were green on the day ). There are also more buy idea levels that could be triggered soon. Not a Premium subscriber yet? Go Premium and receive my Stock Trading Alerts that include the full analysis and key price levels.
Related: What’s Your Trade Ahead of the Fed? Wooden Opportunity?
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