The FOMC meeting is tomorrow at 2 PM. Fed funds rate puts the chances of a 25bp rate cut at ~ 50%. The market will likely rally if there is a rate cut and fall if there is not. Either decision can be taken as positive or negative. Base case is the fed cuts 25 bp and markets rally to new ATH, this would put the S&P above 3040. Scenario B is the fed does not cut rates and markets sell off, technically a sell off would catch many traders off guard and as a result the S&P could close below 2970. Scenario C is the fed cuts rates but markets take the rate cut as evidence of a more dire economic future. Regardless of the immediate reaction to the FOMC speech, there are certain trades that have a high probability of success.
The first is shorting high growth stocks with high forward looking P/E ratios which are largely held by institutional investors. Institutions are aware that the probability of a recession is rising and the inversion of the yield curve has signaled that it will happen in the next two years. Companies dependent on rapid revenue growth are more than likely to continue to revise earnings estimates downwards in the coming years. The probability of this scenario is extremely high. This is part of the reason why growth stocks have been sold on this rally and value stocks have been bought. The risk for growth stocks is now primarily to the down side. The second is buying gold, oil or bonds on a pullback. Gold and bonds have entered structural bull markets, while oil arguably has as well.
In the case of gold, QE which central banks in Europe and the US have already implemented will continue to rise. This will cause inflation over time and devalue all currencies. QE could also cause central banks to begin competitively devaluing their currency, which will further accelerate inflation.
In the case of bonds, yields are at record lows around the world as central banks have reduced interest rates below zero and now people are actually paying banks to hold their money. US treasury bonds will persistently be bought on any pullback as a result.
The case for oil is less clear and frankly has a relatively low probability of success compared to these other trades. Insecurity in the middle east has begun once again as Iran has begun to instigate Saudi Arabia. The situation in the Middle East has been brewing for some time and is currently being underplayed by President Trump. Iran will likely continue to attempt to disrupt the global oil supply in an attempt to gain political leverage. Countries around the world including Saudi Arabia and The United States have strategic oil reserves that will last more than six months. Saudi Arabia has stated that it will restore the capacity of its oil production completely by the end of the month. Buying oil on a pullback requires some doubt in Saudi Arabia’s ability to repair its facilities within six months. The base case is that global economic uncertainty will continue to suppress oil prices in the medium term. Despite this primary headwind for oil, the price of oil has been quite low and producers have cut back on production as a result. Ramping up production in the US will take time and in the short term oil prices will likely continue to rise due to increased supply uncertainty. Any structural bull market in oil requires demand beyond what is expected in the next twelve to twenty four months.
Thank you for reading and as always feel free to comment or email me with any questions.