I think that analysis is solid, decent probabilities for those outcomes, which is why I plan to release half my S&P shorts just prior to the Dec decision, and put them back on if it goes higher. But that’s just the short-term move emotional move.
What I think is very likely – people charge in to pump up the index and show a gain for the year. But in Jan they take a look around, prices at S&P2150, thus ttm valuation at 23.5X, and Q4 earnings expected to decline -7% from prior year, the 5th straight EPS decline, and things get real. The fact is it’s an earnings recession and that can’t be covered up with fake stats forever.
^ Oh I know investors are irrational, especially late bull market. But eventually they are forced to become rational…as the bad data becomes too much to ignore, and someone big runs for the door, greed then turns to fear, and it’s game over.
Look at 2007 as an example. The bad data kept piling up, anyone with their ear to the ground knew subprime was nonsense, EPS was down 22% in Q4 from its Q2 peak, yet the index was still almost 1500, people holding on wishing. If we go back and look at forward earnings in Q4 (I don’t have that data), probably they were expecting some miracle back then too? The miracle better come fast!
For me it makes sense that way, that the Fed might seize good economic conditions at the moment (labour market, rising salaries) to raise rates and be confident that capital markets are stable enough to absorp that hike. The US economy is in the 24th quarter of an upswing, the average cycle is about 29 quarters long. Maybe markets expect further stimuli, but at the moment, Fed seems out of prospects.
Ha, well we are both trying to psychoanalyze the market. Not that surprising we’d come to different outcomes. Extrapolating Dec 1 futures out for the rest of the month, I’d say you’re right. And, that is probably about as good as my analysis on short-term market psychology.
I haven’t really thought carefully about this recently, so it took me a while to consider what I think here. But here’s my result:
I can’t imagine that anyone who is genuinely afraid of a rate hike is still exposed to the market, so to that extent, it is likely “priced in”.
That doesn’t mean that people might not change their strategy once a rate hike is announced. It’s also true that people may have pulled X% out into cash and may change to X%+Y% once a rate is guaranteed, or reallocate Y% back into risky assets for a while if a rate hike is pushed off another month.
So then there are those who either are buy and hold investors who will stick with their same exposure whether or not a rate hike happens, and those who are fund managers with mandates that do not allow them not to be fully invested (but perhaps will do a sector rotation).
There will be some traders who make bets around the announcement, but I suspect these actors will be using futures, and some number of amateurs will be using ETFs because they can’t stomach or meet the margin requirements for futures. They will add to volatility but probably not have much of a long-term effect on the market.
I think the real risk is that people may be underestimating their risk tolerance (as is common after long bullish runs) and then cut and run from risky assets after the initial inevitable bump to prices. This could snowball. My tactical allocation hasn’t been doing very well this year, but has now moved to about 50% cash, and although this is a systematic strategy, it seems sensible to me, because there if a rate cut isn’t announced, it seems unlikely that it will extend low rates that much longer, and if a rate cut is announced, then there is dry powder to allocate where necessary. Interestingly, it is still somewhat exposed to equities, but has cut its fixed income allocations markedly.
Which impact do you expect on FX? Esp. EURUSD seems to have adapted to the divergence in rates, although some IBs still expect the USD to become stronger (e.g. GS at 0,95). Draghi is set to deliver on Thursday, an extension of asset puchases and a decrease in the deposit rate (which is already negative!). I think that we´ll see a small jump in the FX rate when central banks take their action, but after that there´s no more space for the USD to rise.
Though we are told “the market thinks it is a near certainty”, and that is what fed fund futures show, that could be wrong. The market could secretly think they won’t actually do it. I was long until recently, and I don’t believe they will actually do it. Certainly a lot of skeptical people out there think something will happen in the next two weeks (like today’s contracting PMI) that will give them a credible excuse to chicken out.
But yeah, either way, the shock of it actually happening, if they thought it would or wouldn’t, could trigger some action. A lot of young hot shots on Wall Street have never seen a rate hike before.
The market is a discounting mechanism for unknown future events. When people say “the market is efficient,” many people think that it means “the market is all-knowing.” But the market gets things wrong too, and that doesn’t mean it’s inefficient.
The market being efficient just means that all portfolios other than the market portfolio contain risks that don’t have any compensating risk premium over time. Of course, this depends on believing that all non-beta related returns are unpredictable, which hasn’t been proven (nor is likely ever to be proved). That said, an awful lot of active investors underperform simple indexes, so it takes a lot of confidence and/or hubris and/or luck to outperform the market on a risk-adjusted basis. Risk adjustment is important because you can always magnify returns via leverage.
So if markets being efficient or close-to-efficient doesn’t mean they can predict the future, what would “Priced in” mean?
To me, “Priced in” means that there is no large (in terms of (#s * AUM)) group of investors who have been asleep and are likely to wake up and see the data we have already been looking at and suddenly think “oh, we haven’t considered that and need to readjust our price or willingness to buy.” The rate increase has been so much of a discussion now that investors who are following markets have almost certainly had time to consider what they intend to do if rates go up, which is why I think it is “priced in.”
Now I’m about to say something that may appear to contradict what I just said, and I admit that the dividing line is a bit fuzzy in this case.
Presumably there are lots and lots of retail investors that are not all that financially literate. When the Fed raises rates, the stock market is likely to have a bump down (maybe smaller than we’d expect, because of the wierd moment in which bad news on interest rate signals confidence in the economy), and financial pundits are likely to talk about how this will raise the cost of capital and slow down economic activity and tell them that stocks are in for a rough time. This could wake that sector of society up and have them change their strategies and liquidate. So maybe those guys have not been contributing to the prices there.
I don’t think that’s quite the same as “priced in” because at that point, the set of known economic data changes markedly. Even if I think there is an 80% chance of a rate hike, I may have two different plans for the day after depending on whether it actually happens or not. My position today is based in part on what those two plans are, and the probability I have of executing one vs the other.
But a large bump like 50bps or 75bps might really shake things up and have some big knock-on effects. I don’t think it’s likely to happen, but that’s the sort of outside possibility that could really roil stuff up, and I wouldn’t say it’s unthinkable, even if it’s unlikely.
Perhaps the way of the Fed is to say “Our target is that the Fed Funds rate should get to 2% by a year from now, but that the exact timing of interest rate jumps is going to be a surprise.” This might be a way to get the economy to prepare for higher rates but not be playing cat-and-mouse every monthly Fed meeting.
True, but in addition, investors are humans, emotional, driven by perceptions.
Things are relative ; if Aug never happened, the rate hike might be a big freaky thing, but after such a freak out in Aug, the rate hike now seems like nothing, relativity! Because it’s relative though, that price-in could change, and suddenly the same thing which was nothing last week, could seem like something next week. We see this all the time in markets.
People criticize me for trying to be precise (or accurate, in a nod to S2k) with my language and they think this is just semantics or philosophizing, but if you don’t know what you said or haven’t used the words that communicate what you mean, then you can’t discover when you’ve made a mistake, and that impedes learning from mistakes.
If you’re a strategist who’s job is to convince people that you’ve never made a mistake, then being imprecise is fine, but if you’re a buyside analyst, then words are important, because they mean you have thought through your logic.
That doesn’t mean that everyone else has to be privy to your logic, but if you are not able to verbalize precisely what you are thinking, then you are acting on gut feel in the fuzzy areas. Some people’s guts can be tuned into the current zeitgeist, but zeitgeist can be a fickle friend wherein a gut feel that was working for years suddenly can turn against you and be wrong time after time.
It’s good to be precise with your language, not just for academic reasons, but because you understand the world around you better and can respond to it appropriately.
Sticking with my call that the probabiity of a hike is significantly less than implied by market numbers, and that if they DO hike a serious market disturbance could result. Remember, every time it has been “high probability”, yet every time it didn’t happen.
The fed must be scared shitless right now, this is seriously a house of cards “let’s raise during an earnings recession, and a stock bubble peak that we created”, has that ever happened before? But the clock is running out and they need to make a move soon. The pressure is on, the whole world is watching to see if you can actually exit QE/ZIRP, internally congress is questioning the fed’s reckless policies, it will be embarrassing if it goes wrong.
^ Haha, well yeah! But according to Bernanke and friends, who already claimed victory, it was a massive success and everyone in the world should imitate this brilliant strategy! What could go wrong?
China has been the only hold out, they claim the policies are irresponsible and there will be a price when the bubble pops (over the Summer they said the chaos was due to the developed world central bank bubble becoming unstable, not due to their slowing growth). Oh man, China will be doing a huge “I told you so”, adding to the global embarrassment, and further increasing their position as the responsible ones with “prudent” policies, deserving of reserve currency.