After falling 10% from the January highs, the leading US indices are again exhibiting strong technical momentum, largely supported by bullish earnings outlook and PE expansion for the large technology names.
In Saturday’s post, we looked at the “higher low” formation in the Dow Jones and the need to stay long the index whilst the low of 24,247 remains in place.
We now include an up trending support line and re-affirm the long side positioning, with a trailing stop loss below the up trending support.
As expected, the US FOMC voted to keep rates unchanged last night but signalled that it still expects one more rate hike before the end of the year.
If that’s the case, then the FED Funds target will have been lifted from .25% to 1.50% in just over 12 months. The “Dot plots” were revised slightly lower from 3.0% to 2.75% by the end of 2019.
The response from US stock indexes was muted, but we expect the combination of higher borrowing costs and the reduction of the FED balance sheet to temper any significant gains in US equities into the end of the year.
This coming Tuesday and Wednesday, the FOMC will meet to discuss the next move in US monetary policy.
Over the last several months, it’s been well-telegraphed that this meeting will focus on unwinding QE and shrinking their balance sheet. The amounts and the mechanics have already been announced. Now it’s just a matter of announcing a starting date.
US financial markets have been brushing off the Fed and have done the opposite of what the Fed has set out to accomplish.
The Fed wants to tighten US financial conditions. It’s worried about asset prices and that these inflated assets, which are used as collateral by the banks, pose a danger to financial stability.
The FED has mentioned several inflated asset classes by name, including equity prices and commercial real estate, which backs $4 trillion in loans heavily concentrated at regional banks.
The FED has raised rates four times since December 2015, including three times over the past nine months. As the chart below illustrates, the relationship between the DOW Jones Index and the FED’s balance sheet is highly correlated.
As such, the FED’s decision could be a prime driver of US equities next week.
During yesterday’s Asian session and into the London time frame, investors were anxious about North Korea’s provocative missile launch, the flooding disaster in Texas, and the looming US debt ceiling debate.
However, once the US session opened, investor’s attenton turned to preparing for the Labor Day long weekend, which marks the end of the Northern Summer.
The NYSE will close early on Friday and will remain closed all day next Monday.
Volume on the Dow Jones 30 was barely 220 million, down 25% from the 3 month rolling average of 310 million per day.
As the chart below illustrates, the SP 500 remains below the 30-day moving average with a downward bias.