We are seeing the now usual run-up in stock prices ahead of an expected US Federal Reserve rate hike.
This has become the standard recipe for short-term trading success in recent months. The story usually goes something like this, everyone knows there is going to be a rate hike, and therefore the bad news is already priced in. The clever thing to do is to fade that ‘sell the rumour’ downward force, by ‘buying the fact’. That is the actuality of the rate hike.
This is common trading and investing tactic. It has also been called the “front page effect”. Where once a market movement became big enough to be prominently displayed on the front page of the regular newspaper, then it was time to trade that market in the opposite direction.
This time, however, things are different. The reason such approaches have worked throughout history is that once everyone who wants to buy a market has done so, it can only go down. What the buyers fail to realise, is that once everyone is long, they, become nothing more than a ‘sea of potential sellers.
This time, regarding the Federal Reserve most definitely hiking rates by 75 points, this is so well known and the previous effectiveness of this approach so self-evident, that it is indeed the whole herd which has now begun to buy for just such an outcome. That being, the market will rally on the fact, because it is so widely expected.
My point is that if everyone is buying because it is an obvious ’sell the rumour, buy the fact’ event, then after the actuality of the Federal Reserve rate hike, it will not be a market that is caught short, but one that is already long. That is, the real fade trade here is to wait for the disappointment of current buyers after the initial knee-jerk buying response runs its course, and emphatically sell.
After all, the economic fundamentals are deteriorating across the USA and Europe and the global economy is most definitely slowing.
The fundamental backdrop is so bearish, with no end to the current economic slowdown in sight, and the positioning will have become long-biased, that this rate hike could quickly trigger a fresh and renewed sell-off.
The initial ‘buy the fact’ rally has the potential to last for 3-36 hours, but any turning down below the lows of today before the event could be just the trigger needed to confirm the next major down-wave in this monumental bear market had begun.
Treat the Fed rate hike with the utmost respect, but be cautious of any initial market strength. The dominant overall risk remains very much to the downside.
Market insights and analysis from Clifford Bennett, Chief Economist at ACY Securities
