Will the Next Worry be a Fed Funds Rate Increase?

Last week, for a very brief stay, our Psychology Composite moved to P5, which is a more cautious level than the previous level of P4.  To dip into P5, the Psychology Composite indicators have to be below their weakest 20% level of the full range of possibilities.  However, after Friday's close, this composite has moved back to its P4 level, just based on a few indicators showing some improvement.  You can read more about our Psychology Composite's move to P5 in Friday's post by clicking here.

This morning, I want to share a few thoughts about the recent evolutions of our Monetary Composite.  It is as natural as day following night that when the news gets better, the Fed will see less need for monetary liquidity. Their words are just a deception of how they are interpreting their stance, as they DON'T go from hot to cold overnight - it is a steady evolution.  Our composite of 37 parameters simply looks at history and lets the market's actual performance tell us what our asset allocation should be.    Today, we still have a Monetary Composite rating of M1, its best rating, but it is not the same as the M1 we had a few months ago.  Instead, it is gradually evolving toward that threshold that would move it one notch to M2.

I can only imagine how the news will interpret every wiggle in the market in the months ahead.  Investors have been coveting any hint of better economic news.  So now, that is what we are getting.  As a result, Psychology is showing a little more optimism in the pits.  You would think this might last a while, but that is not what happens in "Investor Land."  You never get to relax during bull markets until those last stages when you are feeling extra confident about the future, and then, Mr. Market is ready to pull the plug.  What will keep the herd unsettled in the next few months?  Our guess is that the herd will start worrying over the Fed making a statement that they plan to move away from their historic liquidity.  We haven't had anything like today's liquidity in recent history, but we have seen this evolving over-sensitivity to an impending Fed Funds rate hike before, so let's look at the market's reaction.

Click on the image above to view a larger chart.

The middle chart above shows how the bond market reacted pre- and post-Fed action, but the real bottom line of the above charts is to show that when the Fed began to remove the over-flowing punch bowl, it has not created any serious market reaction in past circumstances.  It does often, however, create a little short term volatility.  I believe the improving news of the next 3-4 months will cause the "worriers" to start sending their Fed warnings out to the headlines.

A little returning worry would be good for the long-term staying power of this bull market.  However, it needs to be evolving.  We need to see the investor start to re-emerge into stocks.  It is happening...a little, but not much yet.  It will happen, but we believe the BIG MONEY floating around the world looking for a home will continue for a while to be the main stimulus of this bull market.

Don Hays

If you are a subscriber to HaysAdvisory.com, click here to read today's Market Comment.  If you would like to learn more about the research and commentary offered by Hays Advisory, click here.

Please see important disclosures at the bottom of this page.