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Market Lab Report - Premarket Pulse 8/29/16

Major averages finished Friday's roller coaster ride mixed but near breakeven, closing roughly midbar on higher volume after managing a bounce later in the day.

At her annual speech in Jackson Hole, Federal Reserve Chairwoman Janet Yellen said the case for another interest rate hike is strengthening. “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months."

While markets at first fell on the news, they then strongly rallied suggesting that Yellen's speech contained no surprises. Indeed, she later said that any decision on interest rates “always depends on the degree to which incoming data continues to confirm the Fed policy committee’s outlook.”

That said, markets then once again fell as perma-hawk Fed Vice Chair Stanley Fischer said the upcoming jobs report for August would be important in determining the FOMC's September rate decision and suggested a rate hike in September could be appropriate. A number of other Fed members including Jim Paulsen, Dennis Lockhart, and Loretta Mester Mester have also echoed the sentiment, but always qualifying their hawkish stance by saying the data would have to back up any such decision.

The St. Louis branch’s James Bullard, meanwhile, has forecast only one rate hike over the next two-and-a-half years.

Yellen noted that while economic growth has not been rapid the labor market has seen “continued solid performance” with job gains now averaging 190,000 over the past three months. But this begs the question about the reliability of this statistic among others. Indeed, we know the CPI has been grossly distorted over time which artificially boosts the GDP. We also know that the unemployment rate fails to count those who have given up looking for work. We also know that the nonfarm payrolls number includes many temp style jobs. Indeed, many major companies across the planet have cut back substantially on full-time hires as that trend intensifies. When a company doubts that the economy really is improving, it adds temporary workers as there is no long-term commitment, thus management can cut them at will.

So despite Yellen suggesting solid performance of the labor market and a good outlook for inflation, she spent the bulk of her speech discussing the potential need to add new tools to the Fed’s toolkit to combat the next recession given that interest rates remain so low that further rate reductions may have limited impact. She said Fed officials “may wish to explore the possibility of purchasing a broader range of assets.” She did not mention negative interest rates, though she is on record saying negative rates are always an option.

Notably, Yellen said “70 percent probability that the federal funds rate will be between 0 and 3-1/4 percent at the end of next year,” a huge range that allows for any number of unexpected shocks. So she is leaving the door open to all possibilities.

Judging by the CME Group’s FedWatch tool, markets assigned a probability of just 18% to a September hike going into the speech, but after the speech, the odds rose to 30% in September and 58% at the December 14 meeting.

In other words, interest rate futures markets are digesting the Fed's relatively hawkish comments from Fed officials and Yellen’s own statement at Jackson Hole, but the situation remains fluid. Keep in mind that if the economy were truly on the mend such that a rate hike was warranted, the markets may interpret that as a bullish sign and surprise the majority by rallying. The delay of a rate hike can cause a market correction such as in the second half of September 2015 when the Fed said a hike would be delayed due to economic woes at home and in China.

Nevertheless, when it comes to stocks, let your stocks tell you when to buy and when to sell as news can be a distraction. When a stop is hit, ask no questions but simply sell since things can quickly get worse before they get better.

And as we have always advised, while the VIX Volatility Model has done well, it is a different strategy than how one should trade stocks so its buy and sell signals should not influence one's stock holdings. The Market Direction Model can at times be used as a guide especially in prior markets that were not so heavily influenced by quantitative easing, but ultimately, our shorter term trading strategies of taking profits when you have them in context with a stock's chart and keeping stops tight should be based primarily on what your stocks tell you to do. Our Focus List, Weekend Review, and any stocks you have placed on your personal watch list should be your main guides.

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