Monday's Sell-Off Respects Fed's Printing Press
Low Volume Shows Lack of Bearish Conviction
While a three-to-five day correction in stocks is overdue, Monday's sell-off was not overly concerning. The first session of the week can be categorized as healthy consolidation.
Volume is an excellent way to measure the collective desire to buy or sell an investment. When a security drops on strong volume, it tells us the conviction of sellers was stronger than the conviction of buyers. After the Fed's announcement on Thursday, investors expressed a strong desire to rid themselves of conservative investments.
As shown in the table below, the Treasury ETF (TLT) and consumer staples ETF (XLP) both sold-off Friday on well above average volume. The desire to reacquire these defensive assets on Monday was not particularly strong, as the gains in TLT and XLP occurred on well below average volume. The low volume gains in TLT and XLP on Monday are a good sign for the bulls.
QE Is Different This Time
The portion of Thursday's Fed statement below is what spooked holders of cash, bonds, and consumer staples late last week:
If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
From the Fed's perspective, QE1 and QE2 had one major flaw in terms of being able to keep asset prices propped up. The first two programs had clearly defined dollar amounts of assets to be purchased, as well as specific termination dates. In the early stages of the first two bond-buying campaigns, stocks and high beta assets shot higher. However, markets eventually looked ahead to the programs' termination dates and began to fall again.
How has the Fed "fixed" this flaw in the third asset purchase program? The market was not given a fixed dollar amount or a well-defined termination date to watch on the calendar. The Fed will print, assess, and then print some more if "the outlook for the labor market does not improve substantially." Thus, the markets have adopted the terms "open-ended" or "QE infinity". This marks a significant shift in Fed policy and leans bullish for stocks, precious metals (SLV), and commodities (DBC).
Intermediate-Term Charts Are Still Bullish
The following ETFs and markets are covered in the video: NASDAQ at 3:21 mark (QQQ), Dow 3:49 (DIA), S&P 500 4:36 (SPY), U.S. dollar 5:57 (UUP), small caps 6:51 (IWM), basic materials 7:50 (XLB), stocks relative to the aggregate bond index 8:56 (AGG), stocks relative to intermediate-term Treasuries 10:42 (IEF), and consumer staples (XLP) relative to consumer discretionary 12:42 (XLY).
When a broad market, such as the NYSE Composite, breaks to the upside, it illustrates healthy participation during a rally. Point A in the chart below of the NYSE Composite shows a clear break above a trendline that has acted as resistance for five years. As long as the breakout holds, the odds favor higher highs in stocks over the coming months.
The bullish arguments we made on August 10 and September 7 remain in place. Therefore, we will continue to hold a reflation-friendly portfolio, which includes miners (GDX), foreign stocks (VEU), energy (XOP), and basic materials (XLB).