Upcoming Jobs Report Could Spur a Fed-Fueled Stock Meltdown

From Chris Ciovacco: With an important piece of economic data due in just a few days, and its potential ramifications for Fed policy, it pays to compare our current market environment to those of the past.

Repeat Of August 2015/January 2016?

The Federal Reserve is once again talking about raising interest rates. With a key labor report due to be released Friday, the markets could react sharply to any news that may increase the odds of a September rate hike. The Fed played a role in both the August 2015 and January 2016 waterfall declines (see below). Therefore, it is prudent to ask:

How vulnerable are stocks to another sharp sell-off?
How Does The Current Market Compare?

The charts below show the two waterfall plunges in stock prices that have taken place over the past year. We can learn something about the present day by comparing August 2016 to the pre-plunge market profiles in August 2015 and January 2016.

Concern Before 2015 and 2016 Sell-Offs

When the net aggregate opinion of all market participants is positive regarding future market and economic outcomes, stocks tend to rise. Conversely, when the net aggregate opinion of all market participants is negative, stocks tend to drop. Therefore, we can gain an understanding of the battle between market confidence and market fear by looking at charts and price action.

Notice how in the 2015 chart below, the S&P 500 was making a series of lower highs that began almost three months before the August 2015 plunge. Similarly, the series of lower highs began two months before the January 2016 “mini crash” in the S&P 500. In both cases, just before the big plunge, the S&P 500 was below almost every single moving average. The slopes of the moving averages in both charts were indicative of the market’s indecisive and vulnerable nature.

How Vulnerable Is The Market To A Waterfall Decline?

Compare and contrast the pre-plunge profiles (first two charts below) to the present day profile (third chart below). The S&P 500’s last new high was made eleven trading sessions ago, which is quite a bit different than the other higher-risk periods where the S&P had peaked months before. Notice how instead of price being below most of the moving averages, it is now above all of them, which indicates much stronger bullish conviction today relative to bearish conviction. The slopes of the moving averages are also much healthier in the present day.

Fed-Induced Volatility

There is no question when the Fed starts to ramp up talk of a possible rate hike, the stock market becomes more vulnerable to episodes of volatility and/or a sell-off. Markets “price in” Fed expectations. The current market odds for a September rate hike stand at 24%, meaning the market puts the odds of the Fed doing nothing at 76%.

Waterfall Odds Lower Today

The takeaway from the charts above is the odds of a waterfall decline are lower today than they were in August 2015 and January 2016. The present day market also has higher odds of recovering after any pullback. As noted in detail on August 29, pullbacks and volatility are a normal part of any bullish trend; a concept that applies to all market profiles. Regardless of the market’s profile (good/bad/indifferent), the odds of a waterfall decline are never zero, telling us remain open to all outcomes over the next few weeks.

DIA-2016-08-30

Investors are sending a bearish signal to the Fed today, with the SPDR Dow Jones Industrial Average ETF (NYSE:DIA) falling $0.37 (-0.20%) to $184.46 in afternoon trading. The DIA, which is the largest ETF that tracks the DJIA, has gained 6% year-to-date.

This article is brought to you courtesy of Ciovacco Capital.