A Market Timing Report published Monday September 14th, 2015
I deliver focused comments on the markets. These are supplemented with “Tweets/StockTwits” (see links below).
This is an important supplement to my view of what will happen if the Fed raises rates. You’ll see cheaper prices at some point…potentially far cheaper, exceeding 10% lower than the current market level. Fortunately, things look far better when you look out an entire year.
9-17-2015 UPDATE: SP500 Sector response about 53 min after the decision…can change rapidly!
Before then, this sort of retest that we saw in 2011 could happen in reaction to the Fed raising rates, even if it’s “just” 0.25%…
Face it, the Fed COULD raise rates. They’ve said they’re leaning that way, so the fact that the markets are NOT fully prepared for it (75% believe they won’t raise rates based on futures bets per @CNBC), could cause trouble.
History shows that for the last 6 Federal Reserve rate hikes ranging in date from 3-26-84 to 6-29-04, the mean return for the market (SP500, SPX, SPY) over the next year was 11.07%. There were paper losses in between in many cases however.
The worst paper loss was after the 1986 hike in the form of the 1987 Crash which was marked by “Black Monday” which was similar to the Flash Crashes of 2010 and 2015, but much, much worse. Now we have circuit breakers that kick in. Then we had nothing.
The lowest initial loss (within the first month) was in 1986 of “just” 2.45% and the highest losses within the entire year following the rate hike day were in 1994 with a loss of 9.6% and in 1987 with a loss of 12.49% at the lowest point. It’s important to note that 5/6 times, the market sold off at least another 5% after the hike before recovering in 5/6 cases.
However, the year finished off much better (1 year after the hike): By the anniversary data in 1995, the market was only down 0.7% and in 1987 the market was down 1.84%. There were huge gains in 1987 if you sold on time. Again the mean return was 11.07% which is excellent.
The rate hike year 1994 was not a good year for buy and hold investors. Only the traders made money selling high and buying back low. As said, the worst loss that year was 9.6% from the day just prior to the hike day and the anniversary date showed a loss of 0.70%. This means the very worst year after a rate hike was not fun, but very survivable for even buy and hold investors.
CONCLUSION: We need to have some cash on hand to buy more should the Fed raise rates on Thursday. Expect the volatility index to remain elevated (VIX). Remember that all of the above does not apply if the Fed DOES NOT raise rates. The markets will likely rally short (days) to intermediate term (a few weeks) if they do not raise on Thursday.
Earnings could be a big problem for the markets, which come in early October. The markets may quickly shift their focus there once the Fed decision is out of the way.
If they DO raise rates this week, we’ll likely see discounts in the market over the next year ranging from a few percent to a full correction of more than another 10% off pre-rate hike pricing (history showed the smallest discount of 2.45% to the highest discount of 12.49% off pre-hike prices for just these six data points.)
Remember that it could be far worse than a 12.49% loss should the Fed be very stupid and raise rates repeatedly. I don’t feel that is likely. The other variables are the huge Fed balance sheet and Chinese (and others) selling U.S. Treasuries.
Rapidly rising rates in the face of world economic weakness would throw the U.S. into recession and result in stock market losses exceeding a total of at least 20% from the all time high in my opinion. Not likely, but you must understand the risks, not just the opportunity of the Fed NOT hiking rates on Thursday.
What am I doing? I have about 7% cash vs. my usual maximum equity exposure worldwide (follow it on Twitter/StockTwits), but realize that I have far more cash to deploy if things go south. You’ll have to decide what you are comfortable with. Being overleveraged LONG into an unknown with fairly significant discounts to come if the Fed DOES raise rates may not be the smartest approach.
Be sure to read my latest thinking about market sentiment and what the Fed’s choices are (update at the top): HERE
Standard Disclaimer: It’s your money and your decision as to how to invest it.
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