The Fed May Have Just Unleashed The Stock Market

The Fed just put the brakes on raising rates in 2019, and it should come as no surprise to anyone that reads this commentary regularly. It will result in rates falling across the yield curve and as I have told you before this is bullish for equities and will allow for multiple expansion as investors move further out on the risk curve.

It is also supportive of my view that we talk about regarding the earnings multiple for 2020 which is well below the historical average. Again, it all points to stocks continuing to rise and it may have only started.

PE ratio

(Data from Dow Jones S&P)

Thank Draghi

We can go back to March 7 to understand why the Fed got to where it is today. Since March 7 the S&P 500 is up about 2.75%, and the NASDAQ is up about 4.15%.  In case you forgot that was the day that Draghi saved stocks. I wrote on March 7: Again, this move by Draghi puts Powell in a box and essentially puts the Fed on hold for the balance of the year.

When the ECB moved to a more dovish stance and became more accommodative, it put the Fed in a tough spot. The Fed had two choices: stay the course and risk a dollar that would soar, sending inflationary force sharply lower, or put any thought of raising rates in 2019 on hold. They chose to go along with the ECB.

Buying Treasuries

I think perhaps more important than the Fed’s pausing its rate hikes is this statement: Beginning in October 2019, principal payments received from agency debt and agency MBS holdings will be reinvested in Treasury securities via secondary market purchases subject to a maximum amount of $20 billion per month; any principal payments in excess of $20 billion will continue to be reinvested in agency MBS in a manner consistent with current practices.

Notice the via secondary market purchases subject to a maximum amount of $20 billion per month;

Essentially, it is a swap out of MBS holdings and increasing Treasury holdings. It is an effort to keep the Fed’s balance sheet steady. However, it will create an underlying bid in the Treasury market since the Fed will be buying the Treasuries on the secondary market.

We can see how Treasuries responded. The 10-Year plunged nearly seven basis point to 2.53% below the previous low of 2.54%. It opens the door to a genuine possibility of rates on the 10-year falling to around 2.3%.

rates

The 2-year fell below support at 2.47% today and what once seemed like a fantasy, is now a reality with the door opened to a decline to 2.2%.

2-year

There is a massive bond buyer now on deck, and everyone knows they are coming.  To give you a sense of what $20 billion per month is, it is half of the monthly QE3 purchases, which were at $40 billion per month. 

Again, this is NOT new money coming into the system, just the creation of a bid as the Fed swaps from MBS to Treasuries.

S&P 500 (SPY)

The S&P 500 did initially jump on the news but pulled back by days end once investors realized this is not good news for the bank stocks. But the good news is that the S&P 500 tested and held 2,812 mid-day.

S&P 500, spx

Banks

The BKX Bank Index fell 3% today. The index rose and then failed at resistance around 102. The bad news is that there may be even more declines to come should the index drop below support at 97, with the potential to first fall to 94 and then 88.

bank index

Netflix (NFLXWealth Strength IndexAAPL is Extremely Up and trending Up)

Netflix exploded higher today rising by over 4.5% to $375, and now finally closing in on resistance at $378. A rise above resistance sends the stock to $405. The RSI suggests more gains are on the way too.

nflx, netflix

Amazon (AMZNWealth Strength IndexAAPL is Extremely Up and trending Up)

Amazon took off today and appears to be on a path to $1850. I explore the FANG stocks today in more depth. Is FANG Back?

amazon

Micron (MUWealth Strength IndexAAPL is Extremely Up and trending Up)

Micron guided to $4.8 billion at the mid-point for the fiscal third quarter versus estimates of $5.3 billion. Non-GAAP gross margins are expected to be 38.5% at the mid-point down from 50.2% in the second quarter? Wow. The stock is trading higher too? Bizarre.

Notice how the stock is stalling out at $42.10 — a significant resistance region. I’d be surprised if this stock is up tomorrow.  I will have to look at the conference call transcript.

micron, mu

I think that is enough for today.

-Mike

This article first appeared on Mott Capital.

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