The FOMC tightened the money supply on Tuesday by raising the Fed funds rate by 25 basis points to 3.75%, for the 11th time in about 18 months. Consequently SPX fell more than 30 points Tuesday to Thursday, and closed the week down about 23 points, to just over 1,215.
Price stability is the primary objective of the Federal Reserve, because if the Fed targets inflation, growth fluctuates little. However, when the growth is directed inflation fluctuates a lot, which eventually leads to instability. The data show that the Fed has done an excellent job of smoothing out the business cycle done in the past 20 years. Sustainable growth is optimal growth, so the standard of living increases at the fastest possible rate.
The current Fed Funds Rate is still accommodative. Normally, a neutral attitude is more than 5%. However, the Fed has been brilliant in lowering inflation expectations, which lower future inflation, the tightening cycle by using a combination of "jawboning" and actual tightening. Consequently, the economy of above trend growth to growth trend shifted smoothly. The smooth downshift in economic growth is reflected in the stock market. The VIX (S & P 500 Volatility Index) fell below 10 two months ago, which was a multi-decade low. VIX reflects investor fear, and there is little fear of the stock market recently.
The chart below is a weekly chart of the SPX to VIX ratio since 1990. Over time, it will rise and SPX VIX will trade in a range. So, the ratio will increase. Also, there is usually an inverse relationship between SPX and VIX, ie when SPX rises, VIX falls, and vice versa. The 200-week MA (red line) shows the ratio is mean reversion. Typically, when the ratio of 30 to 40 points of the 200-week MA, MA expires this direction. The 40-week MA (blue line) shows a sharp increase over the 2 1/2 year cyclical bull market. Thus, when the ratio rises above 100, care may be needed intermediate term.
Economic reports next week are: Mon: Existing Home Sales, di: New Home Sales and Consumer Confidence, Wed: Orders for durable goods, don: Unemployment Claims, Final GDP and Final GDP deflator, Fri: Personal Income, Personal expenses, Revised Michigan Consumer Sentiment, and Chicago PMI. Notable earnings next week: Monday: WAG, di No, Wed: RIMM RHAT KMG, Thurs: PEP, Fri None.
I believe the market will rise next week in the new district, but there may be some more profit warnings. It seems, end-of-the-quarter window dressing has already been completed (eg oil rose a week ago, while oil prices fell). Volatility can pick up when the result season starts in October, and some stocks rise and other stocks will plummet on earnings. Economic reports and oil prices should continue to influence the market.
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Arthur Albert Eckart is the founder and owner of Peak Trader. Arthur has worked for commercial banks, eg Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds 1999-00. Arthur Eckart has a BA and MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.
Mr Eckart has to maximize a comprehensive trading methodology using economics, portfolio optimization, and technical analysis and minimize risks at the same time and developed over time. This methodology has resulted in excellent returns with low risk over the past four years.
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