Three steps and no stumble…
Technical analyst Edson Gould developed a market rule of thumb known as ‘three steps and a stumble.’ It states stock prices may fall after the Federal Reserve (Fed) raises the Fed funds rate three times in a row without a decline, according to Market Technicians Association.
The idea is three increases show the Fed is serious about keeping rates at a relatively high level for a significant length of time. Higher interest rates could potentially mean higher costs and lower profits for businesses. As a result, stock investors may sell shares and share prices may fall.
Last week, with employment and inflation data approaching Fed targets, the Federal Open Market Committee raised rates for the third time, pushing the Fed funds target rate into the 0.75 percent to 1 percent range, reported Financial Times:
“Fed policymakers’ forecasts for growth and inflation remained little changed, with growth tipped to be 2.1 percent this year and next year, slipping to 1.9 percent in 2019. Core inflation is set to be 1.9 percent in 2017 and 2 percent in the two following years. The possibility of looser fiscal policy emerging from Congress has triggered speculation that the central bank will have to further accelerate its rate-rising campaign, but a number of policymakers are insistent that they want to see firmer plans emerging from Congress before making a call on the impact of possible tax cuts on the economy.”
Major U.S. stock market indices finished the week higher, as did most markets in Europe and Asia. MarketWatch indicated Asian markets were encouraged by indications the Fed may not increase rates as often as expected this year, and CNBC reported European markets were boosted by a better-than-expected outcome for mainstream parties in Dutch elections.
It was a grand slam.
Major U.S. stock markets were positively euphoric following President Trump’s speech on February 28. Optimism about the new administration’s pro-growth policies propelled the four major U.S. stock indices to record highs, despite a dearth of policy details, reported Financial Times.
It’s hard to pinpoint exactly why stocks have moved so far, so quickly. However, it appears that mom-and-pop investors have become quite enthusiastic about the asset class according to data from JPMorgan Chase cited by Bloomberg. While institutional investors (pensions, insurance companies, etc.) have been reducing exposure to stocks, smaller investors have been loading up on shares.
CNBC reported some industry professionals, including Goldman’s chief U.S. equity strategist David Kostin, believe stocks have become too highly valued. ZeroHedge.com quoted Kostin, who said:
“Cognitive dissonance exists in the U.S. stock market. S&P 500 is up 10 percent since the election despite negative EPS [earnings per share] revisions from sell-side analysts…Investors, S&P 500 management teams, and sell-side analysts do not agree on the most likely path forward. On the one hand, investors, corporate managers, and macroeconomic survey data suggest an increase in optimism about future economic growth. In contrast, sell-side analysts have cut consensus 2017E [estimated] adjusted EPS forecasts by 1 percent since the election and ‘hard’ macroeconomic data show only modest improvement.”
Financial Times reported pessimism prevails in the bond market. One bond market professional said, “The bond market is taking a totally different view from the equity market. Blowing raspberries is a good way to put it…There’s no belief that the growth agenda will be dramatic.”
So, is strong economic growth ahead? Do bond investors or stocks investors have it right? Are institutional investors or mom-and-pop investors positioning themselves correctly? Only time will tell.