From Fed to Fundamentals

Todays blog will discuss some factors that suggest a reasonable chance for the current rally to continue – mostly from a “Don’t Fight the Fed, and technical (trend, breadth) perspective. I’ll finish with some current intel on the Fundamentals that will influence the Fed  – which could have negative implications for investors as/if/when the current positive conditions get a little long in the tooth. I’ll call that transition “From Fed to Fundamentals”.


It’s hard to pinpoint when the “Fed- to- Fundamentals” focus might change. But it stands to reason that the move, when it happens, will translate into higher volatility. The VIX is a primary measurement of market volatility. Levels below 20, which it continues to flirt with, is well into the lower end of its pattern. That’s unsustainable. Yet, it did not wash out into the traditional bear market bottom level of below 12. To me, this means the VIX says that markets are somewhat complacent, yet not “market top” complacent. The setup suggests that a change in market focus from Fed to Fundamentals is possible.

Yet, there is another possibility. Note on the chart below my trend arrows (green) for the VIX and for the SPX (bottom pane). They are negatively correlated trends. I’ve placed thick dashed two-way arrows showing this relationship. When the trend for the VIX is down, the trend for the market is up.

In 2022 you can see that the trend for the VIX was up and the opposite trend (down) was seen on the SPX. Very, very early evidence suggests that perhaps we are entering into a trend reversal for the SPX. Its hard to say if that is indicated with a new uptrend in the VIX. As I note with my black boxes on the chart above, bear bottoms are often punctuated with moves by the VIX well over 33. We did see a few tests of 33-36 during 2022. Perhaps that’s all we get. That might be a postive argument for more upside to come.

Looking at the longer termed VIX chart below, you can see that true bear market bottoms are punctuated by VIX levels closer to 45 (circled on the chart below). Note the following market bottoms with such a spike on the VIX: 1998 Asian/ Russian financial bear, the 2002 tech bubble & terrorist attack bottom, the 2009 US banking collapse, and the 2020 COVID crash bottom. These, along with shorter but significant market selloff bottoms, coincided with VIX levels of 45. They are circled below. As noted above, we very well may have seen the highest the VIX may get in this bear. But from an historical level, it would be unusual.

Dumb money

Right now, we have the AAII (American Association of Individual Investors) bear index showing that the bear population is becoming endangered. Yet, it hasn’t reached levels that might indicate a market selloff. On the chart below, the bears hit traditional high levels of fear during the dips of 2022. This is marked by my black arrows. Note that market tops – or lead-ins to those tops – are often signified by an underpopulation of the bears (bottom green line). We are getting there, but – as indicated by my circles on the chart- we are NOT at historic levels where we see a market peak……Yet.

Here’s another way of interpreting the AAI studies. The chart below measures retail investors (AAII) bulls, minus bears. As always, the bull market was punctuated by more bulls than bears in the dumb money world. I’ve circled this on the left side of the chart. This is necessary for a strong market, but at some point the party ends. As the second half of 2021 came around, some of the bulls became timid. Then as markets sold off, they stayed out. Now we are seeing early signs of entry. Again, we need them to sell during the bear phase so we can buy cheap stocks off of them in their panic. They did during 2022. Now, we need them to start buying again if the market is to enter a sustainable bull. It is early. But, some signs suggest they are coming back. Another technical positive, so far.

Industry breadth bullish

Whenever the percentage of industries above their 200 day moving averages cycled from fewer than 10% to more than 90%, the S&P 500 never showed a negative return over the next three or six months, according to a study by “Its average returns were well above average, with low risk. At no point within the next six months did any signal lose more than -5.2%.”

The study highlights when the SPX came off of either bearish/flat periods (2015-16) or bear market selloffs like 2000, 2008 – or recent corrections 2018 or 2022 (chart below), the move back up to broad industry sector participation was sustainable. It lead into bull markets. That’s a point for the bulls, for sure!


Don’t fight the Fed

And now, some words of caution:

Here is an exert from the January Fed meeting summary – note that sentiment was unchanged in the February meeting:

No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023. Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time.”

My take: Despite the FOMC reiterating that there is “no pivot” coming on monetary policy anytime soon, its obvious that bullish investors expect rate cuts!  Some rumblings I have read include projections of lower rates as soon as July of this year….

So- is this a safe bet for the market to assume a rate cut this year?

Rate cuts happen during recessions/ contractions. Fed chair Janice Yellen noted in early February that You don’t have a recession when you have 500,000 jobs and the lowest unemployment rate in more than 50 years.

My take: You can’t have your cake and eat it too. Yes, the Fed may stop hiking rates.  If the economy does have a soft landing, there is no reason for the Federal Reserve to reverse reducing its balance sheet or lower interest rates. Remember, a soft landing means employment is good, production is strong, etc. The Fed needs to retain tighter financial conditions right now to slow economic demand and increase unemployment, lowering inflation toward target levels. So, rates ain’t falling any time soon. Yet the market acts like a cut is just around the corner.

This is important: I discussed the mistake that the Fed made during the 1970’s by easing up after an initial tightening policy this in this blog. As I noted in that blog “This is a mistake the Fed wants to avoid at all costs. They will keep rates tight until inflation is beat.” Here is the CPI chart from that period. Note the spike in inflation in the early 1970’s, which was controlled by monetary policy (as now). As the Fed backed off in tightening – look what happened to CPI in the late 1970’s. Yikes!


Technical factors like market breadth, certain sentiment indicators and trend & momentum studies covered in my “Quick n’ Dirty Market Update” – suggest neartermed upside potential.


The recent risk-on rally in equity and credit markets stands in stark contrast to the slower earnings growth forecast. It’s obvious that the market remains focused on inflation and Fed policy, projecting an unlikely rate cut in 2023. Its also technically driven by momentum – driven by FOMO (Fear Of Missing Out), combined with Pro & Institutional short covering.

At some point, it might be expected that the market’s attention will shift from the question of “What’s the Fed doing?” and more towards the question of “What are we seeing in economic data and fundamentals?”.   At that point, the current positive momentum and trend, as outlined in my “Quick n’ Dirty” update may round over. When that happens is to be determined. How the market reacts – whether via a sideways consolidation, or a pullback, is to be determined. Meanwhile, we will not fight the tape. How we trade now, and in the future, must be dictated by the market.



  • A lot of the earnings conference calls following report dates for US companies this quarter referenced a better second half with pressure from wages, materials etc being offset either through price hikes or internal cost cutting. I did not hear that costs were likely to subside but rather they expected a plateau. Margins in many were up a bit so slowing to sideways inflation should be covered into 2024. Given that markets are forward looking does this commentary or commentary you heard from various companies suggest any further correction may be time rather then price. A sideways period into 2024 seems to be the most likely outcome. Good for traders.

    • Absolutely David- Craig and I wrote a paper a few months back arguing for a prolonged sideways market much like the 1970’s

  • Excellent article. It’s a given that every investor, and their advisors, feel pressure to bring profit performance in their investment portfolios.
    But what is seldomly discussed openly in public, are the hedge funds that short the market, being less and less mentioned in the media, perhaps for fear of angering retail investors and the general public ?

    For every trade, there is an equal and opposite view of what that trade will bring, but only 1 side will be correct.

    Based on the financial media ( Bloomberg, CNBC, etc) many pundits
    simply believe that 2% inflation is impossible, but that is what is required for the Tech Sector and others to see “blue skies” again.

    For example, the revolt by Tim Horton’s franchisees, working for no profit, resulting in the CEO being replaced, demonstrates that costs and supply chains are incapable of mitigating costs. They have not been capable of increasing menu prices to the public for services rendered that meets profit targets and supply chain increases.

    More inflation, means a near nil possibility of borrowing rate cuts in 2023. Cheap money is NOT in the horizon that otherwise would fuel the an overall broad market rally.

    Commodities will continue to move to the upside.


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