Market Does a Head Fake and the Fed Can’t Be Happy About It

After poor earnings reports from Amazon (AMZN) , Microsoft (MSFT) , Meta (META) , and Alphabet (GOOGL) , the logical move was for the market to the sell off. Even the mighty Apple (AAPL) talked about slowing growth and is trading at a price-to-earnings ratio of 24 while anticipating single-digit EPS growth.

However, in the stock market, the most logical move often sets up conditions for the exact opposite action. That is what happened on Friday as the indexes exploded higher on the negative news. The best explanation for the strength wasn’t the great fundamental news. The strength was largely a function of cash flows, poor positioning, short-squeezes, seasonality, the potential midterm election outcome, and hope that the Fed is about to become just a little less hawkish.

The action in Apple is particularly interesting.

Apple did not post a surprisingly strong earnings report. It was not a huge surprise, yet the stock jumped over 7%, which is its single biggest gain since announcing a four-for-one split back on July 31, 2020. Money poured into Apple because it is viewed as a “safe haven” stock that is going to hold up despite the valuation, the economy, or anything else. It is attractive for reasons that have nothing to do with the health of the market.

This sort of “flow” drove the action, but there was also quite a bit of hope about the likelihood of a slightly more friendly Fed. Despite that hope, bonds traded lower on Friday and saw increased inversions between different durations that suggest that a recession is coming.

This is not the first time this year that the market has had high hopes of a dovish pivot by the Fed. Every bounce this year has ended with either hawkish comments from Jerome Powell or economic data that suggest inflation remains elevated. The Fed is releasing its next interest-rated decision on Wednesday, and a big runup into the news is going to create a very dangerous technical setup for the bulls.

It is important to keep in mind that the Fed does not want a big market rally at this juncture. A market rally is inflationary, and it undermines the Fed’s efforts. Even if the Fed does cut its hawkishness a bit, it is likely to be accompanied by some severe rhetoric to remind the market that more hikes are coming and the battle against inflation is not yet over.

We have had a number of huge rallies similar to this so far this year, and they make market players feel very good, but these types of moves almost always lead to elevated volatility in the days ahead. With the Fed and the election coming up, we will have some handy catalysts for more big swings.

Have a great weekend. I’ll see you Monday.