Is This a Trend or a Trap? Here's My Strategy
The market exploded higher following a red wave election and was undeterred late Thursday afternoon when Fed Chair Jerome Powell updated the central bank's current monetary strategy.
The Fed could have derailed the market with a more hawkish bias, but Powell shrugged off the recent spike in interest rates and expressed little concern over the potential for a rebound in inflation. Powell's view was that if economic growth becomes too hot, the Fed can deal with that by pausing its rate-cut program. There was no indication that a hawkish pivot was going to happen any time soon.
The market had a mild reaction to the Fed news and is indicated slightly soft on Friday morning. The trillion-dollar issue now is whether the market can build on the huge breakout move that was triggered by the election or is it a trap for overly exuberant traders and investors who are blind to the many problems that the bears believe will soon come into play.
The bears have two key arguments. The first is that there is far too much optimism about the economy and inflation. The bulls have embraced a Goldilocks economic narrative in which economic growth is strong enough to keep employment solid but not strong enough to cause inflation.
The big worry is that Trump's policies will be inflationary and the budget deficit will increase, but so far, the market doesn't believe it. I suspect there could be political bias infecting the views of some market pundits who are unhappy about the election results and don't want to believe that Trump is going to create the sort of economic utopia the market seems to be indicating.
The other bearish argument is about valuations. The problem with that argument is that outside of the big-cap technology names, valuations are not that excessive, especially in smaller-caps. The Russell 2000 (IWM) has been the big winner the last couple of days because that is where the best stock picking is right now.
The key right now is that the market is not buying the negative economic arguments. That can change quickly, but right now, it is a major tailwind that will help drive a sustained rally.
Technically, things are a bit too hot, and consolidation and profit-taking are likely to occur. The key thing will be whether the big gap that was created on Wednesday morning holds. If it is filled, then the technical picture becomes quite different, but if it holds and dip buyers step up on weakness, then the potential for a sustained trend is very good.
One other positive factor is that we are entering the best time of the year on a seasonal basis. Seasonality is just a tendency and not a certainty, but it is often self-fulfilling to some degree. It can also serve as a tailwind that helps to lessen some of the bearish skepticism.
At this point, I believe there is a good likelihood of a strong trend to finish the year, but it is not going to be a straight-up move. There will be dips and pullbacks that scare the bulls, but I expect key support levels to hold and astute stock picking to be rewarded.
My strategy at this point is to focus on dip-buying and to do some selling into big moves. I need to spend much more time doing research into small-cap stocks with superior fundamentals that have not yet been fully discovered.
We have a soft start on the way, which is exactly what we need right now.
At the time of publication, Rev Shark had no positions in any securities mentioned.