Sell SPY – Market Trouble Ahead On This Fed Path
Market relief following the resolution of the eurozone issue last month will be short-lived. Investors are now fully focused on the likelihood that the Fed will remove the “patient” language from its monetary policy statement next week that will allow for rate hikes thereafter. Over the next 6 months, as investors adjust their perspective to incorporate a rising cost of capital for American corporations, volatility should increase and a market correction is possible. A stock-pickers’ market should result, where favorable ideas can be bought cheaper, but the broader market security, the SPDR S&P 500 (SPY), should present more risk than reward. That market rally I was enthused about last month was short-lived. I would take long bets off the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) now, as volatility is back and a market correction is possible. Investors are now troubled about a rougher road ahead being laid by the Fed’s steps toward a tighter monetary policy. The adjusting market perspective is due to the shocking monthly jobs report just released last Friday. It surprised economists with frosty memories of winters past and expectations for slower economic activity. The all-too-good news has investors today focused on a perceived higher likelihood of Fed rate hikes sooner rather than later. This is a concern that makes for a rocky road ahead. Stocks should be volatile through the rest of the year, and should experience a correction or two. The likelihood of a clear trend-line higher this year is limited by the Fed’s plans. Last month, I correctly saw investor tensions built around fears of a Greece exit from the eurozone as overdone. I anticipated that the resolution I foresaw in Europe would allow pent-up capital that was clearly hidden away in U.S. treasuries, evidenced by historically low interest rates, to run back into stocks. It did, but not for long. You can see a clear move higher starting from February, before we hit a new wall of worry just recently. (3-Month Chart of SPY at Seeking Alpha) Today’s concerns are as important as the eurozone’s potential unraveling was. Today’s issues are more troubling though because Fed monetary tightening is on tap, and will drag on stocks for more than a moment. It cannot be resolved overnight like the Greece issue, despite the latest sensationalism and fear about Greece. For this reason, with Fed rate hikes on tap, I anticipate the possibility of a clear uptrend line for the SPY as very low for the rest of this year. And I believe a market correction or two is highly possible. What changed the recently rosy perspective of investors was the super-strong monthly jobs report just released on Friday. It showed nonfarm payrolls significantly higher than economists expected, and reported the unemployment rate further improved. Economists were likely remembering last winter when they were setting their estimates for the labor market, because this winter has been quite frosty for the Northeast. Boston is still buried in snow. It’s important to remember that labor data lags, and that first-quarter GDP could still disappoint. That’s especially true given that Q4 growth was just revised lower. The Federal Open Market Committee (FOMC) meets a week from Tuesday and issues its latest monetary policy statement next Wednesday. In her testimony to Congress last month, Chairwoman Yellen indicated that the removal of certain limiting language would precede Fed interest rate action, but not necessarily immediately precede it. Still, investors are showing their expectation now that the FOMC will remove the word “patient” from its monetary policy statement, and in so doing, clear the path for rate hikes that could occur at any moment thereafter. It’s important to note that the Fed also speaks about international concerns as a reason for its patience; see the last monetary policy statement . It had been referring to worries that Greece could unravel the eurozone, but it also refers to the danger of a dollar so strong that it hampers American exports. Janet Yellen has indicated that this is an issue the Fed has its eye on. The dollar has been appreciating significantly over the past week, so there is some possibility that the Fed could hold off on the removal of the language. However, the market and I seem to agree the possibility of that is highly unlikely. I believe it’s in the Fed’s interest to remove the language sooner rather than later, to allow the marketplace to reevaluate the relative value of the dollar. Fed rate hikes are a reality investors are going to eventually have to digest. Also, recently some Fed members have expressed an interest to act sooner rather than later so as to enable it to better control the pace of rate hikes, which is in the market’s best interest. Many investors see a June Fed rate hike as possible, and the removal of “patient” language from the March release will stir fear in some. My expectation is that the Fed will first raise rates in September. Nevertheless, the market has not perfectly incorporated Fed rate hikes, and the reality of the situation will force that now. Rate hikes matter because they raise the cost of capital for American corporations. That, in turn, raises the threshold for economic value creation, which impacts market value creation. While rate hikes are not expected to follow a steep path, investors will consider that favorable prospect at some future date. They will also ignore, for now, the fact that the cost of capital will not be significantly increased overnight. This information means that stocks will trade choppy this year, but I would not expect a steady trend-line higher. There is also immediate risk of a market correction as the market adjusts to the changing environment. Investors who bought the SPY on my past recommendation should now sell it. A stock-pickers’ market is in store, so investors will have opportunity to buy favored ideas at better pricing, but the broader market should be avoided for the next 6 months. I cover the market regularly and the SPY ETF, so relative interests may find value in my column . Disclosure: The author is long SPY. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: My SPY position is negligible, and I have an open sell order.