For almost two decades when the junk bond market and the stock market diverged; it was the junk bond market that proved observant. When junk bonds and stocks disagree, Junk bonds tend to be right.
Weakness in the High yield bonds with credit ratings below investment grade and fears of meltdown have increased after high-yield mutual fund Third Avenue Focused Credit Fund, on Thursday blocked investors from withdrawing their money amid a flood of redemption requests and reduced liquidity. If there is going to be a reason for not having a Santa Clause rally it will be the Junk bond market that would spook the celebration.
In our cycle observation we are looking for a low in a matter of days. Most investors think that Fed announcement would make a difference, but it doesn’t. Don’t look to the release date of economic news to be the point for market turns. Those turns are more likely to come before or after the announcement date, when the anticipation of such information will drive trading activity. Remember the saying, “Buy the rumor, and Sell the news.” The reality is that smart money plays against retail investors who pile in because they hear something favorable on the news.
The next FOMC meeting is scheduled for December 15-16th with a press conference by Janet Yellen immediately afterwards. Chances are high they will announce the first interest rate increase since 2006, with the expectation that rates will rise by 0.25% to 0.5%. There will be some gyration around that news hyping the announcement and investors will likely have a knee-jerk reaction. Eventually, the cyclical trends will play out and they will take hold.
Markets are often “relieved” when they know what to expect regarding rates, and a small increase in rates will not significantly alter money flow into the markets. In other words, a small increase won’t become stifling to economic growth, nor will it start siphoning money out of the markets and into Treasuries. That reverse flow doesn’t usually begin until rates approach 4% and higher. However, there is always extreme volatility surrounding rate announcements, so target entries may need to be a little higher to avoid the whipsaw action that is likely to occur on the 16th.
We will not enter into a long trade as long as our intermediate cycle is still pointing down and we prefer to validate a turn instead of anticipate it. We’ll be slightly late at the beginning of the move, but it does get us into the position when short sellers are more likely to keep covering theirs, which can create a powerful rally.