Fed Liftoff and 2016

Fed Liftoff and 2016

After 9.5 years the Federal Reserve raised interest rates by 0.25%.  Despite the media’s coverage, this one interest rate hike alone won’t have any significant impact on individuals.  However, the more that the rates go up over time, the more expensive it becomes to borrow money thereby “tightening” the supply of money.  I don’t believe that the Fed is on pace to rapidly increase rates but would like to build itself a buffer off of zero.

Equity markets have had a fairly muted reaction, but the sentiment is extremely negative.  A recent junk bond fund called Third Avenue ran into significant trouble and the energy and commodities markets continue to struggle.  People are repeatedly saying that after 5 years of very good returns from the S&P 500, the markets are due for weak performance in the years ahead.

I don’t know what 2016 will bring, but making the argument that it will be a bad year because the market was up 200% in the last 5 years is called Gambler’s Fallacy.  This is a mistaken belief, similar to saying that because a flipped coin landed on “heads” 5 times in a row that the odds increase that the next flip will be tails.

If you widen the 5 year look at the S&P 500 to 15 years and focus on rolling returns you see that these returns have been underwhelming compared to relative historic periods.  (Hat Tip Ritholtz Wealth Management)

Image from Ritholtz Wealth Management

What Happens from Here?

So what do the markets do from here?  Nobody knows.  However, I did look back at historical time periods when the S&P 500 had similar moves to Monday.  In doing this I came upon a report by Ari Wald, Chief Technical Strategist from Oppenheimer.

Wald sees the market following the 2011 road map and expects a similar three-stage process: a high-intensity low like yesterday, followed by a relief rally, then another low point reached with lesser intensity. That low-intensity low would "be a sign that selling is abating, a base has sufficiently developed, and that the broad market is ready to inflect higher."

The chart below shows what Wald is referring to:

History doesn’t always repeat itself, but this would be a very normal pattern to watch for.

On a final note, I expect that volatility will continue into the Fall but more on that in my next note…

Some Perspective

At moments like these I think it makes sense to put things into perspective.  That does not discount the worry that comes along with violent downward moves. 

The violent downward moves are exacerbated by the large amount of program trading that exists in the market.  These programs can feed on each other and cause even more selling.

A couple of weeks ago I sent out a market update talking about the dramatic number of stocks that were down over 10% from their highs although the S&P 500 was hardly down.  The last week and what will come today will change that.  The level of the index will now more directly reflect the level of the stocks that compose it.

People will attribute this selloff to China, the emerging markets, commodities, a global economic slowdown and worry about whether or not the Federal Reserve is still providing a backstop to the market.  Regardless of the reason, all of which I am not sure have anything to do with the selloff, sometimes selling begets selling and panic can beget panic.

The US economy remains unchanged from 2 weeks ago.  The market has now more opportunity than it did 2 weeks ago.  It may go down further from here, but we will look for the opportunities that selloffs can create.

To help keep things in perspective here is a chart of the S&P 500 over the past year and also the S&P over the last 5 years.  Looking at the market in a longer term hopefully makes these down moves seem a little less painful.

S&P 500 Over the Last 5 Years