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  Stock Market Rate Hike Peak With Major Risks To Come
 
  2017-01-17
 

 

 

Summary

This year, like last year, has stalled after the recent Fed rate hike.

Markets are numb to eight years of QE and so are ignoring the war of words between the two super powers, the US and China.

Markets are not pricing in enough risk even though material change is coming later this week.

Last year's market stalled and crashed after the first hike in a decade. This year the market also stalled and is waiting for the new administration. The promised trade war can be that catalyst to once again hit markets after a Fed peak.

Peak Just Like Last Year

Here is this year's S&P 500 ETF (NYSEARCA:SPY) chart after the recent hike.

Source: Interactive Brokers

The second rate hike in a decade has so far helped to hold back this record making rally.

Here is last year's S&P 500 ETF chart after the first rate hike in a decade December 2015.

Source: Interactive Brokers

We call out two points in late 2015. We point out the October 28th Fed meeting because they said, "it will be appropriate to raise the target range at its next meeting." That prepared markets for the December hike. Both events acted to help markets stall out.

Markets Holding Up: Can Change Fast

(millions) 01/04/17 12/28/16 12/21/16 12/14/16 12/07/16
Equity -1572 1314 814 19856 5372
Domestic Equity -2067 639 -363 18571 2959

Source: ICI

Markets are holding up thanks to fund flow momentum as cash moved back into the markets. After markets started to move up more money followed adding to the momentum. You can see (above) the two weeks of December 7th and 14th saw large inflows to equity markets. That led to market strength.

 

Source: Interactive Brokers

Above you see the rush of fund flows corresponded to the two weekly jumps in the markets.

After those fund flows stalled markets also stalled.

If markets have any reason to reverse and go back down those fund flows can quickly reverse which will help feed into downside this time.

What Could Cause That Downside? Superpowers At War

There has been a brash exchange between President Elect Donald Trump and China's government sponsored media.

PE Trump said he would consider the One-China policy up for negotiation. The One-China policy states that Taiwan is part of China. Territory disputes are typical reasons for war.

In response China said:

"If Trump is determined to use this gambit in taking office, a period of fierce, damaging interactions will be unavoidable, as Beijing will have no choice but to take off the gloves."

PE Trump's pick for secretary of state Rex Tillerson said that China should abandon their man-made islands in the South China Sea.

In response China again threatened war;

"Unless Washington plans to wage a large-scale war in the South China Sea, any other approaches to prevent Chinese access to the islands will be foolish."

"Better bone up on nuclear power strategies if he wants to force a big nuclear power to withdraw from its own territories."

There is no question that China is claiming to be ready for a war and maybe a nuclear war.

PE Trump has said that his trade policies which are mostly against China will initiate on "day one" of his presidency. These first moves could cause a major confrontation between two superpowers. China is digging in its heals. This is a material market risk.

VIX Complacency

 

Source: Interactive Brokers

Above is the VIX (NYSEARCA:VXX)(NASDAQ:XIV) which measures volatility used for options pricing. It is a quick measure of where markets are pricing risk.

The VIX is at two year lows.

No amount of danger is priced into markets. That is at the same time that a new administration of change is set to take office in the US on Friday.

This new administration is looking to quickly overturn trade deals, Iran sanctions, Russian sanctions, One-China, NATO, NAFTA, UN and many more issues that could itch some other major super powers and cause disruption.

China sword rattling has already begun.

After eight numbing years of quantitative easing central banks have trained investors to look through a lot of bad. This bad could be different.

We think it's very fair to say that the market is incredibly underpricing risk.

If so markets have downside.

Conclusion

Similar to the first hike in decades, markets have shown similar difficulty to make new highs. This time though has major global change as a catalyst with the VIX near its lows. Markets appear to be underpricing risk which spells downside risk.

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Disclaimer:

ETFs reported by Elazar Advisors, LLC are guided by our weekly and monthly methodologies. We have a daily overlay which changes more frequently which is reported to our premium members and could differ from the above report.Portions of this article may have been issued in advance to premium members.All investments have many risks and can lose principal in the short and long term. This article is for information purposes only. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Elazar Advisors, LLC and their related parties harmless. Any trading strategy can lose money and any investor should understand the risks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

 

 

 
 
 
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