The Fed’s Game of Whack-a-Mole

By TradeSmith Research Team

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Why the Fed must cut rates… The latest inflation data… Bad breadth… Did you “buy the rumor, buy the news, then buy some more”?… Trading in an age of chaos…

By Michael Salvatore, Editor, TradeSmith Daily

Allow me to pose what might seem like an absurd question…

Why should the Fed cut rates at all?

No, really. Hear me out.

Inflation is getting under control, with the Consumer Price Index down from the 2022 annual rate peak of 9.1% to 3.1% now (and don’t worry, we’ll get to yesterday’s report).

Economic growth is surging, with real (inflation-adjusted) U.S. GDP at 3.3%.

Even consumers are cheering up, with the University of Michigan Consumer Sentiment index climbing higher and higher from its May 2022 all-time low.

If all these things are true, why should the Fed cut rates?

Why risk reigniting inflation? Why make a move that’s normally meant to stimulate a struggling economy… when the economy’s doing great? The answer lies in Washington…

Take a look at this chart of U.S. government debt interest payments as a share of GDP. Right now, 3.9% of the country’s economy is devoted to just paying interest on the $34 trillion in gross public debt. That’s more than double from 2020.

This fact — not inflation, or the economy, or the stock market — is the ticking time bomb strapped to the Fed’s chest.

Fed officials must cut rates to help prevent government debt from getting even more out of hand. Not to mention, they have the awkward position of not wanting to make major moves ahead of an election… ironically fearing they’d appear politically motivated.

Keep this in mind the next time you think about interest rates. It’s a game of impossible whack-a-mole for the Fed… where the stakes are even bigger than they initially seem.

Raise rates and tamp down inflation… but potentially weaken growth and further indebt the country. Cut them and help the economy and government… and risk causing a second wave of inflation.

It’s a tight spot. But as I’ve been writing here in TradeSmith Daily, investors are winning out.

We just need to keep doing the simple things that almost always work… and taking advantage of the situation we’re in, while it lasts.

Buy great businesses at good prices and hold them, ideally reinvesting dividends along the way. Take advantage of risk-free high yield while you can. Let the Fed do what it will… as if we have any other choice.

And in yesterday’s inflation report, we got a good clue about what that’ll be…

❖ Inflation came in hot again…

The Consumer Price Index (CPI) rose 3.1% year-over-year, against expectations of 2.9%. Over the last month, we saw a rise of 0.3%, also above expectations.

Nobody said the inflation fight was going to be easy. (OK, maybe the Fed did at the beginning… with its “transitory” language.) Yesterday’s report just proves it.

It also casts doubt on the rate cuts Wall Street seems to want so desperately. While stock futures tumbled — the Russell 2000 standing out with a near 4% decline as I write on Tuesday’s open — rate-cut expectations also fell sharply.

Just one day ago, futures data implied a 16% chance of a rate cut at the March FOMC meeting. Today, that number’s all the way down at 6.5%.

Now, you have to go all the way out to June to find a majority agreement on a rate cut. Futures data suggests 53% odds of a 25-point cut by then.

We’re sure to see sustained volatility moving forward from this news. The CPI was just the reason the market needed to sell off.

However, don’t disregard Lucas Downey’s call for a rocky first half to give way to big gains in the second. History shows — from multiple different angles — that’s what we should expect this year.

In the meantime, be watchful of the “guts” of the market. Lately, they don’t look so hot…

❖ The market’s had “bad breadth” all year long…

Take a look at this chart, of the S&P 500 (orange) overlaid on the number of S&P 500 stocks trading above their 50-day moving average (blue) — a so-called market “breadth” indicator.

While it’s far from a 1:1 correlation, we can see that the index generally trends up when more stocks are trading with positive short-term momentum. When the blue line turns down in a significant way, as it did in August 2023, for example, prices tend to follow.

2024 has thus far been the exception. Stock prices continue charging higher, with the S&P 500 clocking 5,000 for the first time ever. But the number of stocks trading well has fallen harshly, from 91 on the first trading day of the year to 64 today.

It’s yet more evidence of the market’s concentration problem, where just a relative handful of companies — especially mega-cap tech stocks — carry the heaviest load.

But is this alone a sell signal? Hard to say, really.

The last time something like this happened, where the disagreement between prices and breadth was so stark, was back in June 2021. Stock prices continued surging higher all the way until December before a bear market began.

This is something to keep an eye on. No matter what inflation or the Fed does, stocks need to go up for the index to go up.

❖ Bitcoin’s back above $50k for the first time since 2021…

And if you’ve been reading TradeSmith Daily, you might be celebrating alongside me…

I’ll admit a small amount of initial regret over my “Buy the Rumor, Buy the News, then Buy Some More” headline.

Once prices plunged 21% following the spot bitcoin ETF approval, it was hard not to… even though I warned that’s exactly what would happen.

Now, though, bitcoin continues its long-term uptrend into a new local high.

And those ETFs are a big reason why. They’ve attracted $9 billion of funds in just a month. Here’s Bloomberg with the details:

Nine new spot Bitcoin funds began trading in the U.S. on Jan. 11 and have attracted more than $9 billion of investor inflows so far. Two of the offerings, from BlackRock Inc. and Fidelity Investments, rank as the most successful ETFs launched based on assets garnered after a month on the market.

As I said several weeks ago, the “sell the ETF news” has set up a “buy the halving rumor” for early May. This is when the incoming supply of bitcoin will be cut in half, as happens every few years.

In the past, this has been a big driver for bitcoin prices — usually culminating in new highs that eclipse the old ones.

I’m positioned for new highs in bitcoin, if not this year then early next.

And I’m not alone.

Trade Cycles analyst William McCanless is a mega bitcoin bull…

Yesterday, he released an excerpt from an in-depth special report he’s writing called “All Roads Lead to Bitcoin 2024.”

And it puts into words what I’ve known intuitively for some time — that bitcoin is an important, breakthrough asset that every investor should own at least a little bit of.

I won’t delve into the details here, as it’s both an early look and exclusive to Trade Cycles members (if you subscribe, access the excerpt here).

But I will say I’m impressed with William’s urgency in sharing this report with his readers, even as it’s so different from what William normally does in Trade Cycles.

See, Trade Cycles is a trading advisory where William holds stock or options positions for just a few weeks on average.

He uses seasonality — a phenomenon of hidden, repeatable patterns in financial assets — to make trades with startling accuracy.

Across 75 trades in 2023, he averaged out a 17.2% gain.

And that’s thanks to TradeSmith’s incredible cycles indicator.

For example, let’s look at what the indicator currently shows on the bitcoin chart.

There are three technical tailwinds for bitcoin we can point out here.

One is that bitcoin is currently in a blue-shaded valley zone (where the blue price line ends). This tells us that now’s a good entry point before bitcoin enters the next orange-shaded peak zone.

Next, note how the purple, long-term cycle line is set to bottom and trend up… while the magenta, composite cycle line — which combines all the cycle lengths we track — is also turning higher.

And both of them top out at the cycle peak around late May of this year.

That lines up really well with the next halving… which doesn’t surprise me at all.

The Trade Cycles indicator uses historical price data to forecast when any asset is set to perform well or poorly. Bitcoin is just another one of those datasets that the Trade Cycles indicator can translate into trading ideas.

According to this chart, an investor who wants to catch a big move higher in bitcoin ought to be buying now… and looking to take some profits in late May.

But for the bitcoin buy-and-holders like William and me, we’ll be using any dips as a long-term buying opportunity.

To your health and wealth,

Michael Salvatore
Editor, TradeSmith Daily