It’s always true to say, “We’ve been here before” when it comes to markets. The trick is figuring out whether the similarities with the past are meaningful, and if they outweigh the inevitable differences.
In the week following a crucial September meeting, the Federal Reserve passed on a chance to move away from emergency-style policy, citing unsettled financial markets and preferring to wait for more data to confirm its forecasts for the economy.
The markets sold off, confused by a dissonant message, as Fed officials stressed that nothing much had changed and everyone was way too focused on the start date of policy “normalization” and losing sight of how gradual the process would be.
This all unfolded in the past several days – and also played almost, almost to a note – in September of 2013. That was when the Fed decided not to “taper” its QE pace. Wall Street then sold off in revolt against the supposedly confused message, before making its peace with the chance it would begin that December, which it did.
This column, from almost exactly two years ago – “Does the Fed have a communication problem, or do markets have a listening problem?” - could have been written yesterday in its most important respects.
After last night’s speech by Fed Chair Yellen firming up prospects for a December rate hike and laying out her expectation for the path of inflation and Fed policy, perhaps the markets can make another uneasy peace with the outlook.
Of course, the markets themselves don’t look terribly similar to late 2013. That was the year of the great melt-up, the most effortless phase of this bull market, and the S&P 500 (^GSPC) went into that September Fed meeting near an all-time high. The post-meeting selloff was a brief, 4% wiggle before a year-end surge.
This year the correction has placed longer-term uptrends in jeopardy, with stock valuations and profit margins in a late-cycle condition.
There are useful analogies from the past, though, when looking at investors’ deep and pervasive skepticism. We’ve not seen investor sentiment as depressed as this since at least the debt panic of late 2011. (U.S. stocks ultimately dropped nearly 20% that year, before roaring ahead to resume their post-crisis recovery.)
This can be seen in the various surveys and in Merrill Lynch’s handy Bull-Bear Index (now flashing “extreme fear”). By some measures, the public hasn't hated stocks this much in 15 years. Traders are loaded up on downside bets against the market, with short interest on the S&P 500 SPDR ETF (SPY) up by 40% in the past two months.
This week has effectively been a test of how much rally fuel can collect, in the form of fearful selling and nervous feeling, before it matters.
The market’s inability to rebound substantially to this point, with so many leaning negative, could support the idea of a market regime shift, to a period when the bull-market rules don’t readily apply.
So let’s see how today’s rally attempt develops, and whether it gives a hint about which moment from the past we might be reliving.
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