Think Market Is Happy About Rate Hike? Think Again

 | Dec 14, 2016 | 2:26 PM EST
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The Federal Reserve has done its best job to crush the Trump Trade.

Wall Street initially sent stocks lower on Wednesday in response to the Fed's first increase in interest rates since last December. While the market certainly expected the lift in rates, what investors may have overlooked is how hawkish it would be in its policy statement. Although stocks quickly bounced back, it's hard to not to view the initial move down as more telling as to how market sentiment may shape up going into year end.

Here is specifically what may be concerning some in the market:

-- "Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since midyear." Take: The Federal Reserve acknowledged the U.S. economy has momentum, which could open up the door to a more consistent path of rate hikes in 2017.

-- "Market-based measures of inflation compensation have moved up considerably." Take: The Federal Reserve is carefully watching the Trump Trade and resulting increase in equity valuations. Maybe the Fed agrees with Bill Gates' comments on Tuesday that stocks are overvalued. Either way, the comments in the FOMC statement on market inflation suggest it's not comfortable with the level of stocks relative to corporate earnings potential in 2017.

-- "Near-term risks to the economic outlook appear roughly balanced." Take: The Federal Reserve sees the economy in fine shape, and capable of handling higher interest rates.

One should be hesitant to take the bait being offered by the bulls right now. While it's hard to ignore the allure of the momentum behind the powerful post-election rally, the Fed looks to have sent some very clear signals on what it will be up to in 2017 as long as economic data continue to improve.

Keep in mind what I wrote on Monday:

In any event, investors have to remember what happened last year after the Fed raised interest rates. There was a delay in reaction, but then you know what hit the fan in January. Last January, the S&P 500 dived 5.1%, and the Dow Jones industrial Average shed 5.5%, for the biggest monthly losses since August and the largest January declines since 2009. The Nasdaq plunged 7.9%, its worst month since May 2010. 

The moves to the downside were convincing, too, causing the selling to just start feeding on itself after a while. January saw the highest monthly average Nasdaq Composite, NYSE Composite and total volume since August 2011. Why did this occur? Pretty simple. 

The market rationalized that the delayed effect (usually six months) of the Fed's first interest rate hike would crush companies in the second half of 2016. Investors, as a result, were trying to reduce their exposure to many overvalued areas of the market (notably emerging markets and tech) before Corporate America delivered surprisingly weak earnings and tepid outlooks. The dire situations didn't pan out as the economy remained nicely resilient during an election year and companies continued to pursue stock buybacks and major acquisitions. First-quarter results for many S&P 500 companies in late January and February helped to quiet the litany of worries brought about by the horrible start to the year's trading.

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