"Expect the best. Prepare for the worst. Capitalize on what comes." --Zig Ziglar
For years the bears have been predicting that a day would come when the markets would lose confidence in the central banks and a nasty downtrend would ensue. After years of financial engineering and near-zero interest rates, the economy is still sputtering and might even been in a danger of falling into a recession. Despite these concerns, central bankers have sounded more hawkish lately and that is what is causing problems for the market.
The recent employment numbers have masked some of the economic problems and have given the Fed the basis for a rate hike. As a result several Fed members made hawkish comments on Friday, and Fed Governor Lael Brainard, who has been a proponent of hikes, is schedule to speak today and make a case for hikes sooner rather than later.
The last time the markets corrected, back in January and February, we had a similar problem. Although the Fed was making a case for hikes, the market was concerned about the international economy. This disagreement between the market and the Fed about the health of the economy is what produced the corrective action. Eventually, Janet Yellen and the Fed adopted a more dovish tone and that ran things up again into the Brexit vote in June. Brexit produced a two-day selloff but the central banks dovish reaction to the news produced a straight-up rally that developed into a two-month-long trading range.
Market players have been anxiously awaiting a resolution of the trading range and it finally occurred Friday. The indices broke to the downside on big volume and wiped out nearly two-months of gains. The gains in the indices haven't been particularly big but the underlying action had been good and now it had suddenly changed.
Over the past six years the market has consistently recovered very quickly from these central banker scares. The bankers are very sensitive to market moves and seem to back off from their hawkish policies when things start to breakdown. Back in February there was coordinated action by central bankers around the world to deal with the poor market action. That worked extremely well and produced a multi-month rally.
Is it different this time? Will the central bankers fail to reassure the markets once again? Is this the beginning of the end for the long-running bull market?
Maybe -- but there is no way to know for sure. What we need to do is respect this poor price action and do what we can to protect our capital just in case this turns into a major downtrend.
The market often makes us feel foolish for playing defense but as I discussed in my column this weekend, selling is simply a form of insurance. It is far more effective than hedging and can be undone in the blink of an eye. Selling is a strategic tool that can save us considerable pain when conditions change.
My plan is to see how well the market can bounce. The dip buyers haven't had an opportunity like this in a while but a play to buy weakness feels quite different when we have this level of carnage. Futures are gapping further down this morning and that is exactly what the dip buyers want to see.
If the dip buyers are going to go to work, the first stocks they will likely grab are key big-cap names such as Facebook (FB) , Alphabet (GOOGL) and Amazon (AMZN) . The big, liquid names will move first and if they hold, watch for the secondary stocks to start finding bids. Whether or not this is a major shift in market direction is not yet clear but we have little choice but to be prepared for the start of a major downtrend.