Why the bull market could survive the Fed’s big policy shift

Stocks could keep marching higher even in the face of expected interest rate hikes and an unprecedented Federal Reserve balance sheet unwind.

Equity markets may face pressure in the short-term, but will likely continue their broad upward trajectory as the central bank hikes interest rates, said Torsten Slok, chief international economist at Deutsche Bank.

Slok said this is largely because as the Fed moves to gradually hike rates (with the next hike likely to come in December), the fundamental economic backdrop is improving modestly.

"The net effect is still, in our view, that we will see equities perform to the upside as the Fed goes through this exit," he said Thursday on CNBC's "Trading Nation."

Specifically, he cited positive points from the latest employment situation report, manufacturing data and early signs of wage growth improvement.

"The broader set of economic indicators is indeed supporting the broader equity market ... and earnings should continue to look relatively decent as we look ahead over the coming quarters," he said.

In fact, Tom McClellan of the McClellan Market Report argues that the market actually hasn't been driven by the Fed for some time.

From the 2009 bottom until 2015, the market rally was driven by the Fed's policies, McClellan said Thursday on "Trading Nation." That preceded something of a pause in the rally in 2016 before a new "organic" bull market emerged and has continued to present as interest rates have risen.

"What's interesting now is that the postelection rally is happening without any QE from the U.S. Federal Reserve. You could argue, well, the Bank of Japan and the European Central Bank are still printing money like crazy, and money's fungible so it's flowing in from there. That may be true, and I don't dispute that, but we're seeing an uptrend that is not attributable to the Fed, and that's kind of the difference now," he said.

Still, Slok said, the risk he is watching at this transitionary period is the issue of running down the central bank's multitrillion-dollar balance sheet built up in the wake of the financial crisis.

"Will it be like watching 'paint dry,' as the Fed has been saying?" Slok asked Thursday, referring to a term Fed officials have used to describe their projected process of its balance sheet deleveraging.

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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