Learning to Expect the Expected

You may have missed it, but buried under headlines of the Electoral College and a kidnapped underwater drone the Federal Reserve met last Wednesday and, in a shocking twist, did exactly what was expected of it.

It raised interest rates .25%.

Even though analysts had been predicting the rise, investors lopped 18 points off the S&P 500 anyway for the largest one-day drop this month. That drop was a measure of just how much uncertainty there is in the markets these days: even the expected surprised us.

Then again, the Fed hasn’t exactly earned a reputation for dependability in the last year. But I think with this move we may be able to start trusting the Fed to stick to a predictable course of action.

And that’s good news. It will be a big step in restoring some level of certainty to the markets, which will let investors return to more rational behavior next year.

The recent rise in the markets, which to my mind is buying stocks blindly in the face of increased uncertainty, strikes me as foolhardy. On the other hand, when prices make little sense that means the market has mispriced many stocks. Good news for finding bargains for my Profit Catalyst Alert service.

Connecting the Dots

The Fed has been trying to become more predictable in the nine years since it started monetary easing to help stimulate the economy after the Great Recession. To that end it developed the Dot Plot, a chart published after each Fed meeting showing the projections of each of the Fed’s 16 members for the level of future interest rates.

The chart includes consensus from the previous Fed meeting, a critical ingredient in analyzing the anticipated direction and slope of interest rates.

This month’s Dot Plot telegraphs an acceleration to the Fed’s current tortoise-like pace of raising interest rates. Seven Fed members now expect the Fed funds rate to equal 1.75% by the end of next year, versus six members looking for 1.5% in the prior meeting. This would equal a more than doubling of today’s .75% rate, and would likely mean three hikes of a quarter of a percent next year.

Of course, like most prognosticators, the Fed reserves the right to change its mind based on any unanticipated squiggle in some economic indicators. A slowdown in job growth or a drop in the consumer price index, a common proxy for inflation levels, could send the Fed back into its cave, where it would wait for more robust news to forge ahead with more rate increases.

It was only last January that the market fell to pieces over the Fed’s first interest rate hike. Back then the economy was sputtering along and investors feared the hike would hobble job growth that was just getting steady on its feet.

Over the past eleven months, the unemployment rate has slowly and steadily improved and job growth has been nursing its way back to health. 

While the market seemed unhappy (albeit briefly) with the boring action of the Fed, I’ll be using what I consider irrational stock moves to pick profitable spots to buy and sell.

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