Rate Cuts, Reality or Are Traders and Investors Delusional?

US stock markets have rallied straight up since the beginning of November, going all the way from the most recent low and correction (down 10% off the highs) territory all the way up to a shallow new high. The Nasdaq 100  technology index is pictured below by the $QQQ ETF.

The broader based index, the S&P 100 represented by the $SPY below, shows the markets rallying into a double top at prior resistance. The S&P is lagging the NASDAQ, but also performing very well for the entire month of November.

Rally Trigger

Let’s start by asking, what set off this explosive rally? Well, the Fed did not raise interest rates at its last meeting, but did indicate that rates would stay higher, and that potentially they may be raising rates again in the near future. That was the exact message from the Federal Reserve chairman, and from the various committee members since the last meeting. Why did the market proceed to rally straight up? And why did the markets read this as a rate cut that would be coming soon? Are Traders and investors just delusional?

“Wall of Worry”

Let’s review the “wall of worry” yet again. First off, consumers are deeply in debt going into the holiday season, but it is still too early to see if they are still spending. Secondly, there has been a truce in the war in Israel which helped to drive the markets slightly higher in the last week of so.  Inflation numbers indicate that inflation has slowed but is still at about 4.0% per year, which is twice the Fed’s target inflation rate; even as oil prices recede below $75 a barrel due to demand slow downs. This Indicates the opposite, that the Fed might raise rates if oil prices start to rise again, or just if inflation does not continue to drop over time.

The chart above of $USO, which is the Oil ETF, shows the recent drop in the price of oil, but a higher low on the daily chart shows that Oil prices might be getting ready to rise as winter arrives in the northern hemisphere.

The stock markets seem to have been trained to only react to one thing, and that is interest rate speculation. This is a very bad situation for investors, but not as bad for short term traders. Unrealistic expectations will most likely end in disappointment, as the Fed has yet to say they plan on cutting rates. When the Fed continues on its directives and has to raise rates by even a quarter of a basis point, the expectation in the markets will be completely disappointed. Traders and investors will then have to face the reality that interest rates will most likely be going higher and will stay high for the foreseeable future.

When indicators are divergent that is often a signal for change, so let’s try to read the markets objectively and err on the side of caution. Trade Well until next month.

Written by Michael DiGioia, Director of Education
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