Stock market investors are addicted to easy money and, just like an addict, they want more easy money.
The bubble in many assets, not only stocks, is getting bigger across the globe. The Federal Reserve pumped more air into the bubble with an interest-rate cut, but not as much air as bulls wanted. The bulls do not like that they did not get what they wanted. Prudent investors are asking, “What now?”
Let’s examine with the help of a chart.
Chart
Please click here for an annotated chart of U.S. Dollar Index ETF UUP, -0.07%. Please note the following:
• The dollar index rises when the U.S. dollar moves higher against a basket of currencies.
• In theory, the dollar should go down on a rate cut and go up on a rate hike. The reason is that money moves out of a currency where the interest rate is cut.
• The chart shows that instead of going down, the dollar moved up on the rate cut.
• The chart shows the dollar previously broke out to the upside instead of breaking down as the Fed decision approached.
• The chart shows a strong up move in the dollar as the rate cut fever picked up steam.
• The dollar has moved up in the face of Trump calling for a weaker dollar. There were even reports that the Trump administration was discussing intervention to lower the dollar.
• On the rate cut, instead of moving up as bulls had been forecasting, the three popular broad-based ETFs, S&P 500 ETF SPY, +0.95%, Nasdaq 100 ETF QQQ, +1.78% and small-cap ETF IWM, +0.40% moved down.
• Gold ETF GLD, +0.46%, silver ETF SLV, -1.62% and gold-miner ETF GDX, +2.45% fell. Precious metal investors were positioned for a strong move up.
• The selling did not spare popular stocks such as Amazon AMZN, +1.26%, Facebook FB, +1.86%, Microsoft MSFT, +3.22% and Apple AAPL, +1.78%.
• The strength in the dollar in the face of a rate cut is a testament to the strength of the U.S. economy.
• I have been advocating that no rate cut was needed, and it appears that the Fed succumbed to political pressure, especially from President Trump. The up move in the dollar on the rate cut shows that the rate cut was not needed.
• Before the rate-cut announcement, in the Morning Capsule that is provided to Arora Report subscribers, we wrote: “On the other hand, if the Fed takes a neutral stance going forward, that will be worse than the expectations and the start of a major selloff.” The market sold off after the rate cut because Chairman Jerome Powell was closer to neutral than the stock bulls wanted.
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What to do now
Even though Powell was closer to neutral than stock bulls wanted, he is still talking about more rate cuts. This should, in theory, dampen any major potential selloff. It is not just that Powell threw cold water on the bulls’ expectations of a prolonged series of rate cuts in the future even if the data did not support such rate cuts.
As I have previously written, the U.S. stock market is like a drunken party where all the drunken people claim nobody is drunk and the punch is still being spiked.
Investors ought to monitor the situation closely in case more risks develop that can lead to a 2008-like selloff in which many investors lost one-half the value of their portfolios. In 2008, when the stock market was falling, the ZYX Asset Allocation Model produced a large gain by using inverse ETFs, hedges and other protective measures. The model gave an aggressive buy signal in 2009 and has stayed bullish since then. But at times like now, we have had defensive measures such as proper allocations to cash and hedges as well as proper portfolio construction to control risks.
I was calling for the Dow Jones Industrial Average DJIA, +0.92% to hit 30,000 points when the benchmark index was at 16,000 at a time when nobody was making such a bullish call. Since then I have repeated that call several times. As an example, please see “Here’s the case for Dow 30,000 in Trump’s first term.” The message is to stay for a while, enjoy the party but know when to leave and, in the meantime, take proper risk-control measures.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.