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Thank you, Janet Yellen, for finally taking a side and clearly stating that an interest rate hike seems likely sometime this year.
And thank you for finally clarifying the sudden emphasis that was placed on developments abroad in the last FOMC statement.
Specifically, thank you for this clarification: "The Committee is monitoring developments abroad, but we do not currently anticipate that the effects of these recent developments on the U.S. economy will prove to be large enough to have a significant effect on the path for policy."
Yellen is helping the banks this morning on higher interest rates prospects. This is not only important for banks, it's important for the S&P 500.
Bank earnings estimates have been under some pressure recently on the inability to realize higher rates.
More importantly, investors are relying on higher bank earnings to balance out the disastrous decline in earnings from energy companies. There are precious few sources of earnings growth right now.
This was another lackluster trading session, characterized by the utter indifference of buyers, despite stocks being down three of the last four days.
I've been talking a lot about the drying up of buying interest lately. There's several reasons this has been happening:
1) Stocks have been drifting lower since the Feddecision. A small but vocal minority (including Bill Gross) have insisted that the market might have been in better shape had the Fed done "one and done" and guided more positively on the U.S. economy.
Since then, we have a global marketplace that has taken another modest downturn on the exact same global slowdown concerns that existed prior to the Fed meeting, only this time the "global slowdown" story has the Fed imprimatur.
In other words, the Fed has successfully "infected" the rest of the world with its concerns over "recent global economic and financial developments."
2) Another group agrees that the market has been drifting lower since the Fed decision, but that the Fed was right and that not only has Chinabeen slowing down, recent economic data indicates the U.S. has been slowing as well.
They point to a series of recent fairly large economic misses:
This camp generally agrees that the Fed may have missed its opportunity to raise rates a few months ago, but with some signs of slowing economic growth, now was not the time to do it.
3) A third group notes that buying interest is weaker because it is obvious that weaker global growth is being manifest in: a) lower commodity prices, and b) negative revenue growth.
They're right. I noted earlier today we are heading for four straight quarters of negative revenue growth:
(S&P 500 revenues)
Q1: Down 2.9%
Q2: Down 3.4%
Q3 (est.): Down 3.3%
Q4 (est): Down 1.4%
We haven't had three quarters of negative revenue growth since 2009; we haven't had four quarters since the financial crisis.
This will be the big story for the remainder of the year.
Volume yesterday was slightly on the heavy side, but it's not the selling I'm concerned with, it's the buying. Or the lack of it.
Is "buy the dip" dead?
With the exception of one or two days, there has been precious little buying interest since the three-day drop in the markets from Aug. 21 to 25.
And why should there be? The markets already have had to deal with the uncertainty of not knowing when, if ever, the Fed is going to raise interest rates.
What bulls need now is some evidence that "buy the dip" does not turn into "sell any rally." Two things are necessary to avoid that.
1) Some evidence the global economy is not falling apart, starting with better data on China, which we did not get overnight. China's Flash Manufacturing PMI came in at 47.0, below expectations of 47.5, its seventh straight month of contraction (below 50) and the lowest print since March 2009.
Every component was weaker, including new orders and employment.
That's not helpful.
You might have woken up this morning and checked U.S. stock futures. You might have noticed they were down roughly 1.5 percent and wondered, "What happened between the close yesterday and overnight that made futures go down 1.5 percent?"
The answer is, not much. There have been no big headlines. Just a few small ones that, collectively, have added up.
Some traders have pointed to a new report from the Asian Development Bank (ADB) that lowered Asian growth forecasts for 2015 and 2016 on softer prospects for India and China.
The ADB now sees GDP for China at 6.8 percent in 2015, down from 7.2 percent earlier. India is projected to grow 7.4 percent, down from an earlier 7.8 percent forecast earlier.
Read MoreADB slices Asia growth forecasts
There was the usual discussion of the knock-on effects of slower China growth on Southeast Asia, as well as soft global commodity prices which puts pressure on Asian commodity-focused export economies like Mongolia, Indonesia, Azerbaijan, and Kazakhstan.
Still, stocks in China ended up fractionally.
European markets opened down modestly and have drifted steadily lower. The dollar is modestly higher, but commodities like copper also began trading lower overnight and have also drifted lower through the morning.
Why are stocks down today? There are several reasons:
1) This is a quadruple witching expiration, the quarterly expiration of stock index futures and options, and individual stock futures and options, with large volume and volatility at the open and close;
2) Oil is down almost 4 percent, a proxy for global growth;
3) The Federal Reserve has sent a message to investors: it is more concerned about global growth than it had let on.
Let's focus on the Fed for a moment. The central bank clearly stated it was concerned about the state of the global economy and its impact on the U.S. Bank of America/Merrill Lynch summed it up Friday morning: "The Fed acknowledged our concerns for global weakness, and this acknowledgement is a bearish signal for risk assets."
Now that the Federal Reserve has made its decision—for better or worse—it's time to turn to what really matters: 1) the state of the U.S. economy, 2) the state of the rest of the world, and the impact this has for corporate revenues and earnings.
To the extent that the Fed lowered its expectations for growth, that is certainly a negative sign for earnings.
And earnings and revenues could use some help. The second half of the year was supposed to see an improvement over the first half's flat earnings growth, and negative revenue growth. Not happening.
Here's the current Q3 estimates from FactSet:
Earnings: -4.4 percent
Revenue: -2.9 percent
Much of this disappointment is due to energy, where earnings are expected to again be down a stunning 65 percent. That's not a typo—65 percent. If you remove energy, the S&P earnings would be positive 3.1 percent, revenues would be positive 2.7 percent.
Well. That was something. Even though the Fed did not move, they did surprise.
Did the Fed just introduce a third mandate?
This is the sentence that had everyone talking: "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."
This is a remarkable statement.
Fed Chair Janet Yellen repeated this again during her press conference, specifically calling out slowing growth in the Chinese economy as a factor in their decision and noting the future risk there of "a more abrupt slowdown than some analysts expect."
So the Fed's mandate is: 1) job creation, 2) control of inflation, and 3) everything else (global economic and financial developments)?
Some will argue this is an exaggeration. The Fed is not introducing a third mandate, they are merely acknowledging the interconnection of the global economy. It's all appropriate, some will argue.
And there is certainly a practical consideration: the Fed may not want a stronger dollar, no matter what they say, because of the negative impact on corporate profits.
Having introduced the global economy as a factor in your decision-making, how do you turn this ship around? Do you not raise rates until the Shanghai stock index recovers? What's the criteria for that? Are we also now "data dependent" on Chinese GDP?
There's a real problem when the Fed starts acting as the global banker of last resort.
Trying to reduce the September Federal Open Market Committee meeting to game theory, the question becomes, "How do you win?"
Let's get one thing clear. A lot of traders have already won, and so the question becomes how to avoid losing. In the last five days, the S&P 500 is up 2.2 percent. A lot of traders have adopted a "sell the news" position. In other words, they either sold at the close Wednesday or will lighten up on the announcement, regardless of what the decision is.
I'm in the minority on this, but I believe the most likely scenario for the markets to rise still rests on the "one and done" scenario.
There's a lot of "ifs" here. If Yellen stumbles, if she fails to convince that the economy is strong enough, or implies another rate hike is imminent, the whole thing could fall apart. A muddled message would be a disaster.
Some of Tuesday's rally could likely be attributed to traders front-running a well-known Wall Street phenomenon: the tendency of stocks to rise in the 24-hour period before an Federal Open Market Committee announcement.
It's called "The Pre-FOMC Announcement Drift." Traders have been aware of this phenomenon for years, but the observation was given a research imprimatur in 2013 when David Lucca and Emanuel Moench, two officials with the Federal Reserve Bank of New York, published a paper on the phenomenon, noting that the move up was real and "orders of magnitude larger than those outside the 24-hour pre-FOMC window."
They not only said the phenomenon was real, they quantified it. Since 1994, the S&P 500 is up an average 0.49 percent in the 24 hours before an FOMC announcement.
Lucca and Moench not only noted this was an outsized return, they made an even more startling claim: the returns over those eight yearly FOMC meetings accounts for 80 percent of annual realized excess stock returns.
That got a lot of attention on trading desks.
Moreover, Lucca and Moench concluded that some other major foreign stock markets exhibit "similarly large and significant pre-FOMC returns" but that no similar effect in Treasuries was discerned.
Other macroeconomic news releases, such as the employment report, GDP and initial claims, also don't have the same effect on stocks.
Why does this effect exist? Lucca and Moench speculated that it may be a premium required by investors for bearing "non-diversifiable risk." That is, investors want more to hold stocks going into an uncertain policy announcement. However, they ultimately conclude that they aren't quite sure why the effect occurs and conclude that the drift remains "a puzzle."
Regardless, the phenomenon is certainly real, and we have even begun seeing attempts to jump ahead of the trend, which may explain a good part of yesterday's rally.
Why is volatility dropping going into the Fed meeting?
It's happening again—the CBOE Volatility Index, a measure of how panicked investors are about the stock market—is down again today. It's been mostly in a downtrend for three weeks, ever since briefly spiking over 50.
Those fears have not gone away. Yet the VIX has been dropping. What does this mean? It is implying that traders believe the Fed decision this week is not going to create a lot of volatility…whether they raise rates or not.
That seems a bit strange, given this is one of the biggest Fed meetings in years, and a rate hike is still very much on the table, and no one is quite sure what the market reaction will be if they do raise rates.
What's going on? The short answer is that on a longer term basis, the VIX is elevated—it's been trading mostly between 13 and 16 for the past couple years, with occasional spikes over 20.
Still, it's not elevated much. At 22, the VIX is implying a move of roughly 2 percent up or down in the S&P 500 in the near-term.
That's not much; many think given the uncertainty about the implications of a rate hike, the VIX should be in the 30s.
Why aren't investors panicking and buying more protection? Volatility traders I have spoken with in the past couple days offer several explanations:
1) Many traders DID panic and buy protection: worries over the Fed raising rates, along with concerns about China imploding, is precisely why the market suddenly turned south three weeks ago and the VIX briefly spiked over 50.
Traders who bet on a spike in volatility won: they sold their positions and made a bunch of money.
2) The majority of traders are taking their cues from the Fed Funds market, which is assigning the probability of a hike to only roughly 30 percent. Because buying protection has become more expensive, many traders have concluded it is not worth the price.
3) even if the Fed raises, most traders believe it is "one and done" (for a while), and that the beginning of hiking cycles has been very strong for the markets.
One final point: there's not a lot of panic about the coming months either. VIX futures contracts for October, November, and December are all in the low 20s as well.
So does all this mean that the markets are free and clear? I don't think so. Global growth—not the Fed—is the issue that is clearly the most concern for the markets.
You can see this in oil, which many consider a proxy for global growth. Big daily moves in oil definitely have translated into moves in equities, particularly energy, basic materials, and industrials. According to Credit Suisse, 70 percent of the volatility in oil on a daily basis is transferred into U.S. equities.
That's a sign that global growth is the big story to watch.
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