There's an old saying among traders: "Don't fight the Fed." Despite this warning, the stock market is fighting the Fed, and for now, it appears to be winning.
Let's consider four recent data points: GDP, retail sales, the Consumer Price Index, and non-farm payrolls. All four of these closely watched statistics point toward a strengthening economy:
- 26: Fourth-quarter GDP, actual 2.9%, estimate 2.6%
- 3: December non-farm payrolls (job creation), actual 517,000, estimate 200,000
- 14: January CPI, actual 6.4% (annual rate), estimate 6.2%
- 15: January retail sales, actual 3%, estimate 1.9%
Suddenly, recession calls that were ubiquitous late last year have all but evaporated. We've gone from hard landing to soft landing to no landing -- full speed ahead.
As if on cue, the dip buyers are back. Much like the Kansas City Chiefs, stocks rallied back from big deficits this week. Tuesday's CPI and Wednesday's retail sales reports led to sharp pullbacks, but by Wednesday's close, the S&P 500 was higher than it was prior to those reports.
Despite this week's news -- which indicates that the Federal Open Market Committee still has work to do -- stocks continue to grind higher. The S&P 500 continues to rise within a bull channel (green lines), and stocks are clinging to the center of the channel (shaded yellow).
In the short term, that shaded area is the key. If the index can break above 4,200, short-covering should propel it to the upper end of the channel, allowing the trend to resume. On the other hand, a break below 4,050 could attract selling pressure, pushing the S&P 500 to the lower end of the channel.
Chart Source: TradeStation
The constant drip of strong economic news should weigh on stocks because interest rates now need to move higher. Interest rates are moving higher, as evidenced by the 5% yield achieved by the six-month Treasury note this week. That's a 16-year high.
Logic would seem to indicate that a guaranteed 5% return is going to draw some money away from stocks, but it hasn't happened yet. "Don't fight the Fed" is a time-tested philosophy, but investors must choose between fighting the Fed and fighting the trend.
Here's my strategy: If the S&P 500 breaks above 4,200, I'll increase the size of my long positions. I still have plenty of dry powder because I've been reluctant to fight the Fed.
If the index falls below 4,050, I'll sit tight because there is massive support in the 3,940-3,975 area. In that location, the bullish trendline of the channel (green), the 50-day moving average (blue) and the 200-day moving average (red) all reside. As long as the S&P 500 remains above those support levels, there is no reason to sell.
