I know normal people have been preoccupied with the “coup in Canberra” or the Abbott for Turnbull PM swap (or whatever you want to call it) but for finance types like me, this week has been all about the US Federal Reserve and its huge decision on whether it would raise interest rates for the first time since the GFC!
The decision was made known to us at 4am this morning but for Wall Street, it was a Thursday afternoon announcement and the stock market has responded.
Ahead of the decision no one was sure how stock markets would react. Let me run through the scenarios before I tell you what actually happened and maybe how you should play this development.
For starters, it has long been held that when the Fed raised official interest rates from virtually zero to 0.25 per cent (or 25 basis points) that the stock market would have convulsions and sell off.
It was then thought that this immediate or short-term reaction would be countered by wise investors saying “well, hang on, the Fed is only doing this because the US economy is getting so economically strong that it actually can take, and in fact needs, higher interest rates.”
Therefore we expected to see a nice rise for US stock markets, after the initial panic of the first interest rate rise.
But something changed in August, as the chart below shows:
This shows what happened to the best indicator of stock market performance on Wall Street — the S&P 500, which fell from around 2120 to 1867 — nearly a 12 per cent dive!
But as you can see, the market has sneaked back so some analysts are saying that the anticipated sell off with the first interest rate rise has happened in advance — stock markets often do that — so when the Fed raises, we actually could see the market go higher.
The chart below shows that we haven’t had the same bounce but we have had the sell off, which was around 16% at its worst!
There was always a good chance that when the Fed moved, we could see the opposite of the old market maxim of “buy-the-rumour, sell-the-fact”, with this rare market challenge bringing with it a “sell-the-rumour, buy-the-fact” outcome.
Whatever the reaction, I was poised to be a buyer of stocks, as I think markets will rally into year’s end and especially so if the Fed got this first rate rise over and done with.
If I was a gambler, I would have bought before the decision but I’m an investor trying to build wealth so I prefer to get on a rising trend or get in when I think a downward trend is about to turn.
So what was the Fed’s decision and what happened on Wall Street? And how am I going to play this new fact?
There’s been no change! Yep, Janet Yellen and the Fed team squibbed it.
The stock market went up but not by much in the early stages just after the decision, probably indicating that if rates had gone up, the market would have sold off.
The bottom line conclusion from the Fed’s associated statement is that it’s more worried about the global economic and financial outlook rather than what’s likely to happen in the US.
This is another act of caution. In that context, it’s less of a concern for the market and explains why the response was for indexes to head higher.
On the other hand, for an optimist, the Fed’s wariness about the global setting and its possible impact on the US says that growth, while expected to be OK in the US, is not expected to go gangbusters any time soon.
Compatible with that conclusion was the Fed’s relaxed view on inflation rising. In fact, it felt like there was a concern that it was not picking up as fast as it would like, again explaining the reluctance to raise rates.
There was an implication that a rise this year is highly likely but, ultimately, it will rest on global developments.
What do I do as an investor or wealth builder?
I suspect this decision will mean more volatility ahead, as market smarties will now have to play “guess what the Fed will do?” again in coming months. The bet will probably be that December is more likely so the market could run higher but another sell off is probably on the cards.
Unfortunately, this delay might disturb my hope for a solid Santa Claus rally if a rise in December brings a short-term sell off.
However, it would only mean that Christmas would come later because I really believe that after a small stock dumping, investors will buy into stocks on the belief that both the US and global economies are heading up.
Given today’s Fed decision, this looks like a pretty smart conclusion.
By the way, after spiking up the Dow Jones index ended down 65 points and the fear index rose.
Yep, I said there would be volatility and it has already started!