Now we know that the Federal Reserve has declined to raise interest rates. What we don’t yet know is that decision’s lasting effect on the stock market.
Last week I wrote that the Sept. 9 selloff, sparked by hawkish comments from the Fed, created an important technical breakdown.
Certain technical ratios that give us a read on the market’s mood and risk aversion weakened ahead of the Sept. 9 decline, but in the days that followed, they actually turned more bullish.
The one thing we know about the market is that it always throws curveballs. But we can use this information to set up the environment in which the Fed’s lack of action will manifest.
Let’s start with the Standard & Poor’s 500 index. After the Sept. 9 downturn, it traded down to touch the top of its former — and huge — two-year trading range.
Bears talk about the breakdown from its smaller two-month range and a drop below its 50-day moving average. Bulls see a test of the long-term breakout and last chance to buy before the next leg higher.
The question now is all about what happens at that test, which is the zone between 2130 and 2135. (The S&P 500 traded at 2146 Wednesday morning.) With the Fed’s decision to hold rates where they are, we should see if that very important support level holds once the volatility from the initial knee-jerk reaction fades.
Now let’s look at the ratios.
Just ahead of the Fed Wednesday, the small-capitalization Russell 2000 index was still outperforming the S&P 500 in 2016. And despite the significant bearish reversal seen in the Sept. 9 decline, it bounced off a long-term support level that goes back to 2014.
As with the S&P 500, whether this support holds is critical, because a breakdown would likely move the performance ratio chart to the downside as well. The market usually has a tougher road when small stocks are left behind.
The next ratio is emerging markets versus the U.S. market. A chart of the iShares MSCI Emerging Markets exchange-traded fund (ticker: EEM) versus the SPDR S&P 500 ETF Trust (SPY) showed a fledgling breakdown a few weeks ago, but it has since reestablished its rising trend. I wrote that the breakdown was bearish, and that is clearly no longer the case now.
And finally, we have the ratio of risky corporate bonds to investment-grade corporate bonds. When the market feels feisty, it is more willing to buy higher-yielding junk bonds, and the ratio rises.
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