Day one of a Fed decision is not always the most reliable indicator on the next move for stocks.
Once the decision hits the wires, it tends to be sentiment that drives the direction of equities and other asset classes into the last few hours of trading. Traders are making snap judgments based on where the market is taking them at the time. It's a war out there in those first few hours, with no time to check spreadsheets and read financial statements.
However, in the days after a Fed decision, investors -- rather than traders -- will usually take over the market, making decisions based on a more thorough analysis of the Fed's actions and what it means to companies and various market sectors. I suspect such analysis will be even more intense following Wednesday's decision, which changes the dynamic for making money in the stock market relative to the past several years.
At least initially, one has to like how the market has responded. Stocks rallied on the Fed decision, then rallied harder as Janet Yellen spoke, as she downplayed any prospect of sustained rate increases next year that would crush the global economy. Overnight, stocks in Asia advanced. Even the battered junk bond market rallied.
It's important for sentiment that "the Fed is still our friend" continues to gain hold today and into the weekend, especially as we start to think about the December employment report (which will likely be solid).
Here are three markets that have to come alive in order to confirm the post-Fed rally.
The Dow Transports began to crumble in late November, which is interesting as we got a solid November employment report, a decent retail sales report and strong housing numbers. I believe the decline has largely been fueled by the sentiment (which now looks misguided) that the Fed would stomp out the economic recovery. Nowhere has this logic played out more than in the railroad space -- shares of Norfolk Southern (NSC), CSX (CSX), Union Pacific (UNP) have absolutely nosedived despite consolidation talk. As an added factor, I think transports have come under pressure on fears of a need to materially increase capex over the next five years to upgrade infrastructure to handle e-commerce shopping demands.
But earnings results from FedEx (FDX) looked pretty decent. The company noted strong holiday shipments while international sales didn't completely fall out of bed. These numbers, coupled with the view emerging from Fed day that the U.S. economy is stronger than people think, should spur the transports into being a leading sector rather than a laggard. If this doesn't begin to happen, like today, I would start to question if the market got its initial assessment of the Fed's move wrong, and paring down positions into January would be the prudent, contrarian course of action.
Good to see the transports rally post Fed news...now it must continue.
Source: Yahoo Finance
Destruction has also found its way to the small-cap Russell 2000. A decent amount of the weakness here could be attributed to: (1) an ongoing industrial recession due to the dollar's strength; (2) the commodities market uprooting many companies, even restaurants positioned near oilfields; and (3) fears that consumers are not spending that much this holiday season.
Of everything I am currently watching, the next move in the Russell 2000 is perhaps the most important. If it advances, it would go a long way to confirm Yellen's confidence on the U.S. economy. If a rally fizzles out, it would be a serious red flag on the health of the economy, on which the market has turned bullish.
I would put a little money behind the iShares Russell 2000 ETF (IWM). Yellen's comments will have some staying power (I believe) and I like the scene right now in retail -- shelves looking very picked over at Target (TGT) and Wal-Mart (WMT) in advance of the final holiday shopping weekend. Bullish comments from FedEx on the holidays are also supportive.
The Russell 2000 has to keep gaining ground, bottom line.
Source: Yahoo Finance
Listen, I am not going to tell you I am a junk bond expert. I am a stock guy through and through and while I understand debt, I am not talking to traders on the Bloomberg terminal about Third Avenue Management. For that nitty gritty analysis, follow TheStreet's Carleton English.
What I am an expert in, however, is common sense. And common sense suggests the junk bond market freefall should at least stabilize in the wake of the Fed decision. Sorry Jeffrey Gundlach. Yellen, I think, actually called a bottom in oil markets at her press conference (which nobody picked up) and had the data behind her decision to suggest the economy can handle the fallout from commodities markets. Further, her comments support the view that companies with high debt levels aren't doing that terribly and could weather higher interest rates -- meaning no massive default wave about to wallop corporate America.
Junk bonds continuing to stabilize is the second most important thing to be watching for post Fed, behind the Russell 2000.
High-yield debt has been destroyed...hopefully Yellen's comments have staying power.
Source: Yahoo Finance