January has been quite bullish. Not just the solid overall gains for stocks, but the very "Risk-On" nature of the groups that outperformed, states Steve Reitmeister of Reitmeister Total Return.
At this stage, investors are holding their breath waiting for the next Fed announcement today at 2:00 pm ET. Anything is possible including a softening of their hawkish stance that would give bulls a green light to keep running ahead.
Just as likely is the Fed doubling down on their previous statements that would have stocks tumbling lower once again. Indeed, a lot hangs on Wednesday's announcement. So, let's discuss how each possible outcome would alter our trading plans.
I see four possible scenarios after this very crucial Fed announcement. Let’s review each and how it would affect our trading plans to carve out profits from the stock market.
Scenario One: Raging Bull (the Bear is Dead!)
In this scenario, the Fed makes a clear and evident pivot in its rate hike regime. Meaning that they see inflation coming down faster than expected and will not have to keep rates high through the end of the year as previously stated.
This unexpected dovish tilt will delight investors as it greatly increases the odds of a soft landing for the economy with stocks raging higher. This should compel investors to abandon their bear market outlook quickly and switch to more Risk-On selections that would outperform in a new bull market.
Or simply, sell everything that did well in 2022 and buy the investments that did poorly last year with an emphasis on growth over value.
Note that I think the odds of the Fed pivoting so obviously at this stage are incredibly low. The next section is the more probable bullish possibility.
Scenario Two: Cautious Bull
Here we get more subtle hints from the Fed of a potential future pivot in the policy. Like they are encouraged by moderating inflation...and will keep rates higher for longer to make sure that rating inflation is good and dead...but just maybe they won’t have to do it for as long as previously stated.
This would increase the current bullish bias in the market. However, the total upside would be more limited as investors would still be too worried about the next Fed statement. And will also be very cautious as they view economic data which is tilting more and more towards recession.
In this case, I would recommend being moderately bullish. Whereas scenario one would compel investors to get back to 100% long...this would be more like 50% long the stock market. And yes, that should be with the same kind of Risk-On selections noted above. Just a smaller allocation with ample cash on hand.
Note that this scenario still leaves open the chance that the Fed stays hawkish too long and we still tip over into recession with the bear market coming back on the scene. That explains why only 50% long as downside risks still exist.
Scenario Three: Bear Returns with a Vengeance
The Fed has proactively talked down bulls at two previous junctures putting an end to premature rallies. I am referring to the famed Jackson Hole speech in August where Powell scared everyone senseless ending the 18% summer rally with new lows in the offing.
A more subtle version of this happened at the beginning of December when he reiterated the “higher rates for longer” mantra more times than I can count. Plus it was clear that they would rather risk recession than leave any flames of inflation in the economy as that is the greater long-term evil.
So if Powell gets back on the “bully pulpit”, or in any way implies that bulls are WAY ahead of themselves, then the bear market comes back with a vengeance. That’s because the longer the Fed stays hawkish...the higher the odds of a hard landing (recession) for the economy.
In this case, stay bearish and stick with the 2022 bear market playbook with inverse ETFs and conservative stocks to squeeze out profits as the market heads lower.
Scenario Four: Dazed & Confused
This is where the Fed gives mixed signals. Still hawkish for a long time to save face given previous statements. And yet do tip their hat a little to moderating inflation.
This gray area leads to a trading range until investors have more facts in hand. I suspect that 4,000 is the low end with 4,200 at the high end. This comes hand in hand with a ton of volatility as each new headline has investors recalibrate the bull/bear odds.
This trading range evolves into one of the three other scenarios in the future depending on future Fed statements and the health of the economy. The more you think it will become like scenario one or two means you tilt more bullish on your trading strategy. And if you still believe that the bearish scenario three is where we end up...then you play the trading range with the same degree of caution.
Yes, there is a lot riding on the Fed statement. I am prepared for any of these scenarios to play out with two and three being the most likely followed by four. No doubt you are thinking to yourself “isn’t there an easier way to invest in the stock market?” Unfortunately not.
The future outlook for the economy, and thus stock prices, is never 100% certain. And thus it is most confusing at the 180-degree turns from bearish to bullish or vice versa. Once we make that big turn, then we get on to the straightaway. Once there the outlook becomes clearer allowing us to enact plans with a greater degree of certainty.
I will of course dissect every word of the Fed announcement to determine which scenario we are in with an appropriate change in trading strategy to quickly follow.
Hold onto the steering wheel tight and be ready for anything!