As 2015 is wrapping up, it’s a good time to review the major markets. It’s also a good time to take inventory, look ahead, and set some goals. In fact, many traders use charts for this very reason: history drawn in plot points and lines can sometimes offer perspective on what may come next.
In this look back, you’ll see uncertainty around Federal Reserve interest rate action and signs of a global economic slowdown reflected in broader stock, bond, currency, and commodity market price action. These unresolved issues could drive the markets again in 2016.
Auld Lang Syne
The S&P 500 (SPX) has been trending up since March of 2009. Every technician knows the “trend is your friend.” One reason for this extended growth has been the Fed’s low interest rates. But these days, the Fed is singing a different tune. Traders and investors worry that potentially tighter interest rate policy risks choking economic growth.
At the same time, a slower global economy could hurt company earnings. It’s against this fundamental backdrop that a technical picture is taking shape. Recent consolidation in SPX has drawn some fairly distinct support and resistance lines (see figure 1). Some chart watchers are convinced that the uptrend could continue if SPX breaks the 2130 resistance line. On the other hand, a break below 1870 support is considered by many as a bearish signal. And of course, the index could always trend sideways as well.
The bears have another reason to feel good about their position: The CBOE Volatility Index (VIX) has established a new, higher low (figure 2), which some chartists read as a signal for a move higher. VIX measures implied volatility, or time value, in options. Higher volatility suggests option traders are unsure of the future direction of the market. Potentially higher interest rates and a global slowdown factor into the uncertainty.
In fact, the VIX tends to rise during bearish times—the August spike in the VIX correlated with the August sell-off in the S&P 500, for instance. Higher volatility makes options more expensive. This means for some traders with this perspective, a focus on selling options versus buying options may be a better strategy than trying to predict market moves.
Watching the Ball Drop
Now, stock traders should seldom make decisions in a market vacuum. Bond action can be a telling indicator. Bond markets are in an interesting predicament as 2015 wraps because the expected new Fed policy of raising rates tends to drive bond prices lower and bond yields higher. However, the policy may also choke stock growth, which will likely prompt some investors to find bonds a more appealing investment.
Buying bonds normally pushes down rates, a sort of counter-punch to the Fed’s tightening action. Ultimately, this could mean that the ball may not drop on bonds after all. Many market participants have argued that there’s a bubble in bonds. They claim that the recent sell-off is proof that the bubble is, if not bursting, at least leaking air. Currently, bond prices appear to be heading toward five-year lows. If the lows give way, that may be the pin bound straight for the bubble.
New Year’s Resolution?
The Fed has been resolute about raising rates sooner versus later, even as soon as later in December. While the ultimate goal is to “normalize” rates, as they’ve said in post-meeting releases, the Fed has also made it clear that they’re in no hurry to reach that goal. And that may allow financial markets to react in an orderly fashion.
In fact, higher rates expectations have already resulted in a stronger U.S. dollar (figure 3). The prospect of rising rates and a slow global economy has helped strengthen the dollar by attracting foreign investors to U.S. markets. A rising dollar is deflationary. This means the price of goods and services may fall, working against the Fed’s efforts to reflate the economy to “normal.” We’ve already seen this with the falling price of oil. Although consumers will benefit, eventually corporate profits could suffer. It will also make it more expensive for foreign countries to sell goods in U.S. markets, which could compound the global economic slowdown, keeping up dollar demand, and so on.
Foreign investors coming to U.S. markets could be the deciding factor for stocks and bonds in coming months. If they feel comfortable with the shift in risk, they’ll potentially buy U.S. stocks and push the market higher. However, if they’re worried about a global contagion reaching the U.S., they’ll likely invest in bonds and keep the bubble from bursting.
Two takeaways: With entangled markets reacting to sometimes conflicting drivers, traders will study stocks exclusively at their own risk. Also risky? Narrowing that study to the present.
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