Major Move After FED Meeting is Often Reversed the Next Day as Bottom Bouncing Continues

Bottom bouncing is a term used by fishermen to describe how they attach a
weight and a lure to a line so that the bait bounces along the bottom, raising
puffs of sand or mud. This action attracts fish and causes them to strike or to start
feeding. “Bottom Bouncing” was the first part of the title of last week’s
Investment Update. As stocks bounce along in the vicinity of the previous
bottoms, attractive prices at 15% off of the highs can attract buyers. The YTD
chart below (from WSJ) shows how the S&P 500 dropped to similar lows in early
March. Now, two months later, stock prices have been trading close to those lows
for almost two weeks.

There have been three huge daily swings in the 3% range in the last week.

The DJIA fell close to 900 points or 3% on Friday, April 28th. When prices fall
this much on a Friday in the later stages of a correction, prices usually continue to
fall sharply on the following Monday and even in the early hours of trading on the
Tuesday after. This is because some investors fret about what is happening over
the weekend. By the time Monday morning comes around they cannot take the
stress anymore and they sell. Therefore, I was surprised to see markets up slightly
on Monday, perhaps because market participants knew the Federal Reserve Board
would be making a scheduled interest rate announcement on Wednesday, May 4th.
A Fed announcement can often be a catalyst for a market reversal after a
correction or bear market. Prices were stable on Tuesday and then spiked close to
3% in the last 100 minutes of trading on Wednesday after the Fed announced a
0.50% interest rate increase at 11:15 am Pacific Time. The chart at the bottom of
the previous page from CNBC shows the DJIA rose 932 points or 2.81% that day.
That was the biggest daily gain since the recovery from the lows after the Covid
sell-off in spring 2020.

Many experts on CNBC were explaining how there was renewed confidence
that the Fed was on top of things and would be able to deal with rising inflation. It
seemed as though we were off to the races except for one thing. I watch the
markets very closely at certain times and have observed an interesting
phenomenon on the day of a Fed announcement. Please see the first sentence of
the last paragraph on page six of my August 1, 2019 Investment Update below.

I have not heard anyone else mention this before. Sure enough, the stocks fell
more than 3% on Thursday following the same pattern they have in the past.
While many were scratching their heads, being surprised when the DJIA fell
1,063 points or 3.12% today, I was not. It was actually a very normal response to
to the previous day's reaction. I cannot explain why this happens but that is not always
important. What is important is to understand how investors behave in the markets
and then accept it. We will be in a much better position to have patience and
discipline when we know what to expect instead of being surprised by what
happens.

Previous Updates have pointed out that the influential financial sector was
acting on a different time cycle than the rest of the market. The long-term
oscillator for BKX shown below was the most oversold since 2008. The small
green arrow in the lower right of this chart shows that the oscillator for this
financial sector is now showing initial signs of reversing. Financial stocks closed
3% above the May 2nd low today.

Please see a Year To Date (YTD) price chart of BKX below.

Please see a YTD chart of the S&P 500 below so you can compare their action.

Please see the oscillator for the S&P 500 below.

The long-term oscillator was rising for the other major market averages until
reversing this week. As mentioned last week, we need to see some follow through
after some strong up days to show that a new uptrend has started. If we have to
drop to being down 20% off of the highs for the S&P 500 to clear the air, you can
see how fast that can happen at this stage of the corrective phase.

At times like this, investors seem to focus on all of the problems and think that
they cannot be resolved. If we do not watch ourselves, we can start to think that
problems like the Russia/Ukraine war, China’s Covid lockdown, rising inflation
and supply chain issues are here to stay. The key to reaching a market bottom is
not to resolve all of the problems. One purpose of a correction or bear market is
to put investors through the wringer to eliminate any excess optimism. Another
purpose is to have the worst-case scenario factored into current prices, which will
exhaust the selling. One set of sentiment data shows pessimism is near all time
highs so it appears markets are very close to doing that.

In the “olden days” before everyone had a clothes washer and dryer, most
homes had a clothes washer with a wringer and an outdoor clothesline. Those
were the days when a spade was a spade and common sense was common. Please
see a photo from shorpy.com on the next page.

After washing the clothes they were put through heavy-duty wringers above
the tub to remove much of the water from the clothes. There was no emergency
shutoff at the wringer and no guides to make sure one’s fingers, arm or clothes did
not get caught it them. People were expected to understand the danger and be very
careful.

The younger generation may not understand what it means to go through the
wringer but the older generation sure does! Every child was trained well to not let
your fingers get anywhere close to the wringer because it was very strong. A
wringer does for clothes like a correction or bear market does for stocks. A
clothes wringer gets rid of excess water in the clothes. A correction gets rid of
excess optimism in the mind of investors and gets stock prices back on a firm
foundation. Clothes get flattened and compressed as they go through the wringer.
The emotions of investors also go through an unpleasant experience as we pass
through a corrective phase.

We are in the middle of a 16 to 18 year growth cycle. Stock prices could triple
in the next 8 to 10 years if history repeats. We want to benefit from that, not be
overly concerned about missing some short-term normal volatility from time to
time. The growth phase from 1982 to 2000 was labelled the buy and hold phase
after it was over because that turned out to be the best strategy over those years. I
would not be surprised if the years from 2012 to 2030 will be seen in the same
way when this growth cycle ends. In the meantime, stocks usually advance for at
least two years after reaching a 2-year low, so good things should be in store for
investors when a new uptrend begins. Reaching this point cannot be rushed, just
like getting through the emotional pain of a severed relationship cannot be rushed.
Now it is just a matter of time to let this emotional process run its course.
Fortunately, it seems as though we are in the later stages of this corrective phase.

 

Please see the photo below.

I drove dirt bikes and road bikes , instead of a car, in the first few years after I
got my driver’s license. I guess I got it out of my system and drove vehicles ever
since until I felt the urge to explore the gravel roads in our area by motorcycle
again two years ago. The weather in the Fraser Valley has been unusually cold
and wet this year but I was able to get in a ride to Jones Lake last weekend to
enjoy some peaceful majestic scenery. Getting out into nature and staring at
mountains that have been there thousands of years helps to put short-term market
gyrations into perspective. Have a great weekend my friend!