Anyone who’s been trading and investing for more than seven or eight years will tell you: Since the 2008 financial crisis, the market has taken on a different personality. Regular infusions of trillions of dollars in freshly created capital might change you, too.
All kidding aside, the U.S. Federal Reserve and other central banks have, with stimulus, changed the very heart of market dynamics.
Things ain’t what they used to be. These days, the markets are driven almost exclusively by one dominant theme at a time.
This is the all-important market “narrative.” Get to know it – really master it – and some of the biggest, fastest profits ever await…
I mention this because the market’s current narrative of optimism could be changing before our very eyes, and it’s so important to stay ahead of the curve…
Here’s How You Make Sense of the Market
Let me show you the last few powerful narrative arcs the markets have followed since 2008. You should see a pattern form, and you’ll see what I mean pretty quickly about how the markets have a “one-track mind” these days.
You’ll probably remember some of these. A few of these arcs lasted years, others were short-lived at a few months or weeks or so, but all were very powerful, and if you were watching them, you were making plenty of profit.
January 2009 – June 2015: The Omnipotence of Central Banks
During this extended run, anything – and I mean anything – that meant more money would be injected by central banks made the markets happy. Anything that threatened the continuation of the monetary gravy train caused drops:
- The prevalence of “good economic news is bad” occurrences. Positive employment number? Stocks go down. Manufacturing falters? Stocks go up…
- European Central Bank President Mario Draghi’s (in)famous “Whatever It Takes” speech in July, 2012, that sent global markets rocketing higher.
- The combination of Standard & Poors’ downgrade of the United States’ debt rating and the European sovereign debt crisis in August 2011 gave the markets a two-month window where it seemed like the central banks may not be in control. U.S. market drops 26%.
June – December 2015: “FANG Is the Thang”
In the last half of 2015, what was good for the so-called “FANG stocks” – Facebook Inc. (Nasdaq: FB), Amazon.com Inc. (Nasdaq: AMZN), Netflix Inc. (Nasdaq: NFLX), and Google (now Alphabet Inc. [Nasdaq: GOOGL]) – was good for the markets. These four tech giants were on a tear, pulling most of the market along for the ride, up and down:
- From March 2015 to August 2015, the market made multiple new all-time highs despite very few stocks following the FANG stocks to their own new highs. This was a poor market breadth that foreshadowed the following…
- On August 24, China’s market meltdown translated into a 1,000-point intraday drop in the Dow and the first 10% correction in the market since 2011.
- FANG stocks lead the recovery from the correction into the beginning of December 2015.
December 2015 – November 2016: It’s All About the Fed (Again)
The first Fed interest rate hike since June 2006 hit in December 2015. Though widely anticipated, the hike combined with a deadlocked Congress and a Chinese growth slowdown to trigger another deep stock drop into February 2015:
- At this point, we were back to “good news is bad for stocks.” With one rate hike in the bag, investors were desperate for clues as to when the next one could happen. They looked in every headline.
November 2016 – June 2017: Trump & the Republican Congress’ Growth Agenda
From the day after Donald Trump was elected, news has been parsed by the markets based on whether or not it would help or hurt the administration’s economic growth agenda.
There have been many proof points, but I can think of few more convincing than this chart of the S&P 500 from February through May 2017, punctuated by U.S. and global events:
The Current Narrative Could Change in a Minute – Here’s Why
There is a very good possibility that we could shift back to a Fed-centric narrative.
As you’ve seen from my Facebook Live coverage of the Fed interest rate hike, the Fed did more than just bump up interest rates by a quarter point.
It did a lot more, in fact…
It announced its formal plan to start pulling some liquidity out of the markets. That’s right – at least some of the trillions in cash it’s been pumping into the markets since 2009 is coming out of circulation.
Here’s what the cash infusion looked like…
In Fed-speak, this is called this “normalizing the balance sheet,” and since 2009, when the Fed injected liquidity into the market by buying trillions of dollars of U.S. government bonds and mortgage-backed securities, its balance sheet has been anything but “normal.”
Essentially, the Fed was purchasing the debt obligations of the government and of homeowners. It was buying up loans.
These purchases put money into the markets and put bonds and securities onto the Fed’s balance sheet.
You can think about it as taking cash out of the Fed’s “vault” and putting bonds and securities into the vault.
When it starts “normalizing,” it’ll essentially “empty the vault” of all those debt obligations and replace them with cash from the markets.
Just as the original infusion boosted markets, this “cash withdrawal” will have a negative impact.
The question is: How big of a negative impact?
The Fed’s hope is it can “normalize” in an orderly manner and not cause a market panic. In the best of all possible scenarios, the cash coming out of the markets would be replaced by cash from U.S. economic growth.
Less desirable outcomes include a declining stock market… or worse.
But the real wild card is this: The Fed hasn’t said one word about when it’ll start “emptying the vault.”
And the events leading up to that announcement will tell us whether or not the narrative has changed.
For now, let me give you the simplest way to know whether our narrative has changed. Just ask yourself two questions:
- Does news that could potentially impact the current growth agenda still move markets?
For example, any positive progress made toward tax cuts should send the market up. If this happens, the Trump-growth narrative is still intact.
- How does the stock market react to economic news and report releases?
Right now, “good news is good news.” For example, good employment reports push the market higher. If “good news” turns back into giving us bad reactions from the stock market, we’ll know that investors and traders are more concerned with the Fed emptying the vault than they are about the Trump-growth narrative.
If we stick with the Trump-growth narrative, it’ll pay to identify extremes that align with that scenario.
And of course, if the narrative changes and the Fed once again lands in the driver’s seat, then volatility will follow. And more volatility equals more profit opportunities.
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