The Fed's New Groove

When you can see a play developing, you have a much greater chance at success than failure. At least that’s what I mentioned in these pages last month.

In the August 25 edition of The Strategic Edge¸ I told you how the recent Jackson Hole Economic Policy Symposium hosted by the Federal Reserve Bank of Kansas City was a tell. In the famed – and anticipated – meeting of leading financial figures, there’s no speaker more important than the Chairman of the Federal Reserve.

For the majority of his tenure, current Fed Chair Jerome Powell – affectionately known as J-Pow – played the curmudgeon. His Scrooge like ways since beginning the fastest rate hike cycle in history were choking off the credit markets.

And it was all in the name of getting inflation under control.

At first, it was necessary. Inflation was raging at its highest level in decades.

But eventually the wave subsided. And the seas calmed.

But J-Pow was stubborn. With his higher-for-longer motto in place, he wasn’t backing down…Until Jackson Hole.

In what we can only suspect were visits from the ghosts of Fed Chairs past, present and future, his Scrooge-like attitude faded. At Jackson Hole, he all but confirmed the Fed was about to shift into a different gear.

As I said last month, he sent a signal that the Fed isn’t focusing on inflation anymore. It’s focusing on the struggling job market. Something we can actually see by taking a look at the Conference Board Consumer Confidence Jobs Index.

This index is part of the Consumer Confidence Survey. It helps assess how consumers look at the current job market. And their expectations for the future.

When it’s rising, it says more people believe the labor market is strong. When it’s falling, it’s a warning sign that the labor market is showing some cracks.

In 2022, the index was at an all-time high of 56.7. It’s been downhill ever since, with the most recent reading at 29.7.

This is what J-Pow and the Fed are looking at. The labor market is cracking. And they can’t let it get any worse.

He handed us the playbook. And last week, we got confirmation of how the play is developing with the Fed lowering interest rates by a quarter point. We also know to expect more rate cuts before the end of the year.

But another interesting thing is happening. There are howls all across the investment world about how it’s crazy to cut rates with the stock market at all-time highs.

It’s almost unprecedented…at least according to those voices.

But is it really? Is this the end of the bull market? Or is it something else?

History may not repeat but it does rhyme. And we have some history with this exact situation. A situation that’s telling us how this may play out in the year ahead.

In the past 30 years, there are two instances where the Fed cut rates with stocks near all-time highs and a cracking labor market: July of 2019 and September of 2024.

What happened next probably caught a lot of investors off guard.

Within the next year, stocks were actually higher. Going against the wisdom of those loud voices calling for markets to collapse. 

But it’s more than that. Going back over the last 45 years, we’ve seen the Fed cut rates more than 20 times with the S&P 500 within 2% of its then all-time high.

Source: Carson Investment Research

In every case, stocks were higher a year later. With an average gain of about 14%.

That’s some strong history. And there’s no reason to think that this time will be much different.

The point is we shouldn’t overthink things. We know the playbook. We know the Fed is most likely going to cut rates further.

Stocks may not go up in a straight line. But for my money, they’re almost certainly going higher over the next year.

As I said last month, I believe some of the greatest beneficiaries will be some of the ignored corners of the market. Like small-cap and micro-cap stocks. And the warrants of those small companies like the ones we focus on here in our Strategic Trader premium service.

In fact we’re even starting to see this play out in the general markets.

Since the Fed’s rate cut announcement last week, the S&P 500 and Dow Jones Industrial Index – which are made up of large-cap stocks – are each up less than1% overall. But the Russel 2000 – which is an index of small-cap stocks – is outperforming its larger counterparts, up more than 2% overall.

This trend is also pushing names in our Strategic Trader premium service higher with current gains of 1,108%, 592%, and 500%, on just a handful of our current open positions.

And with the Fed set to lower rates again in the coming months, there’s a solid chance those trends continue.

Plan accordingly.

Regards,

Editor, Strategic Trader