Market Looks Like It’s Trying To Force Another Federal Reserve Bounce

On a day like today–when U.S. stocks have resumed their downward plunge–the Standard & Poor’s 500 was off 1.91% as of 1:30 p.m. New York time and the Dow Jones Industrial Average was lower by 2.08%–it’s important to remember that the financial markets are not just reactive but proactive.

Yes, they do respond to news and  worries about future news. So today we’ve got a renewal of fears about economic growth, new fears about a U.S.-China trade war after the arrest of the CFO of China’s Huawei by Canada and reports that she will be extradited to the United States, the crumbling of the U.K. government as a Brexit deal looks headed to defeat, and more.

But markets–especially that part of the market dominated by computerized trading–are also proactive. They try to send messages that create the conditions for future profitable trades.

I think the market is doing exactly that today. And I have to tip my cap–in the midst of my own portfolio pain–to the tactics now at work. Because this is one brilliant trade.

Here’s what I think is at work in the proactive part of the market.

Big traders see the chance to make money on the short side of the market right now. There are all those fears that I’ve mentioned above at work. And they’ve got the talking heads and many Wall Street strategists and individual money managers scared, Just look at the headlines on Yahoo Finance or any other site to see exactly how negative the news flow is right now. (Although I would note that the VIX fear index is up a comparatively modest 13.51% today to just 23.51. Clearly some of the pros don’t think this is the end of the world quite yet.)

But here’s the brilliant part of this trade. Each drop in the S&P 500 or in the Dow Jones Industrials sends a message to the Federal Reserve: Don’t raise interest rates or you’ll tank the economy and the stock market. Already the Federal Funds Futures market is betting that the odds for an interest rate increase at the December 16 meeting are no better than 62.9% today. On November 29 the odds were 82.7%. The odds for an additional interest rate increase at the March 20 meeting are now down to 23% and for the May 1 meeting they’re just 27.8%. At the end of last week the odds of an additional interest rate increase–that is beyond the interest rate increase at the December 16 meeting–at either of these 2019 meetings were about 40%. And I’m hearing talk out of Wall Street that the Fed will raise interest rates just once in 2019–instead of three times–or not at all.

If the Federal Reserve doesn’t raise rates on December 16 in response to the market’s meltdown, you can bet we’ll see a bounce like that we got when Fed chair Jerome Powell suggested in a speech that the Fed’s schedule for interest rate increases in 2019 had become less aggressive.

Even if the Federal Reserve raises interest rates on December 16–which is still the most likely outcome of the meeting–but in its post-meeting statement points to the likelihood of fewer rate increases in 2019 than expected just a few weeks ago, you can expect a significant bounce.

And you know where the traders who were positioned to make money on the short side in the current market plunge will be. They will have moved back to the long side in order to catch the Federal Reserve bounce that they helped encourage.

Brilliant as I said.

Maybe you’re a good enough trader to replicate this strategy by shorting the market now and then switching over the the long side closer to December 16. I’m not, unfortunately. Timing this kind of move has never been my strong suit so I’m just going to play this strategy by staying long for the next Federal Reserve bounce.

That won’t be without pain. You can see the algorithms working to drive down the prices of the big export stocks in the Dow Industrials. Today big exporters such as Boeing (BA) and Caterpillar (CAT) were down 4.04% and 2.84% , respectively, as of 1:30 New York time.

Add in the downward influence in the Dow Industrials of Apple (AAPLWealth Strength IndexAAPL is Moderately Flat and trending Up) with its exposure to its Chinese supply chain (down 2.41%), big oil stocks Chevron (CVX) and ExxonMobil (XOM), which were off 3.03% and 2.96%, respectively, and the punishment being dished out to financials that are getting killed because of the belief that the Fed won’t deliver the interest rate increases the banks were counting on to boost earnings (JPMorgan Chase (JPM) is down 3.73% and Goldman Sachs (GS) is off 1.94%) and I think the traders have an easy task ahead of them to push the Dow Industrials and the S&P 500 lower in the short run. Remember that the Dow is calculated giving higher weighting to stocks with higher prices. Odd but true. (A surprise in tomorrow’s jobs report for November could derail this side of the trade for a few days. That report is one reason that I expect to see this decline fade into the close. Do you really want to be short this market in case of good jobs news tomorrow?)

For it’s part it’s hard to see the S&P 500 recovering strongly as long as the financial sector, the biggest or second biggest sector in the index next to technology depending on the day’s prices, is getting killed. Citigroup (C) was down 6.10% as of 1:30 p.m. and Bank of America (BAC) was lower by 4.21%, to take two examples.

It’s “interesting” that the NASDAQ Composite was off “just 1.15% and that big tech stocks such as Amazon (AMZNWealth Strength IndexAMZN is Moderately Flat and trending Up), Alphabet (GOOG), and Netflix (NFLXWealth Strength IndexNFLX is Extremely Down and trending Down) all up. The gains as of 1:30 were 0.75%, 0.84% and 0.73%, respectively.

If there’s another Fed bounce in the cards, I’d expect stocks like these to be big winners. Are some traders already taking positions for the next part of this trade?