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An unexpected announcement from Fed chairman Jay Powell sent the S&P 500 sharply higher yesterday. Powell said U.S. interest rates are near neutral. What he meant is rates will not rise as much as investors had anticipated. At first the reaction in the stock market was positive, higher interest rates hurt the economy, so the sooner they stop rising the better.
But interest rates alone are not the issue, there are other fundamental problems that will continue to be a drag on the economy. In particular the amount of debt has increased significantly since the last crisis. Servicing the debt has become an issue, crisis start when people and corporations have borrowed too much. In this environment raising rates from 0 to 2.5% can have catastrophic consequences.
The Fed knows that, but it’s a bit too late to act. The Fed kept rates too low for too long and in the process reflated the debt bubble. The 2008-2009 crisis is far from over, what the Fed has done is delay the innevitable.
While GDP is growing steadily there are signs the U.S. economy is losing steam. We have seen a number of high profile profit warnings this year, some blue chips stocks like Apple are down 20% or more. Some giant stocks like General Electrics and Sears are worthless. General Motors and other automakers are in trouble, housing stocks are in trouble. New home sales in the US slumped 8.9% from the previous month, they are now at the lowest level since March 2016. President Trumps says the economy is booming, it is hard to believe what he says. I think since he came to power the economy has deteriorated.
The bad news will not go away simply because the Fed stops raising rates, we can expect the bear market to resume when this rally ends. The key is finding the correct level where the S&P will peak and change direction. Not easy, because there are various scenarios in the short term. The FTSE 100 is lagging the S&P because the dollar is now going down and GBP/USD is boosted, this is a drag on the FTSE. But this could change if Brexit does not go according to plan, GBP/USD will drop and the FTSE will rally. The problem at the moment is the Brexit uncertainty, the pound could go anywhere.
What is clear is that the FTSE has broken above a resistance line, it’s moving higher in the short term in line with the S&P. The rally is counter trend hence I call it a dead cat bounce. As markets are generally bullish in December this rally could well continue into December and the bear market will resume in January.
Thierry Laduguie is Trading Strategist at www.e-yield.com
