Bank Failures, Fed Interest Rate Spur Uncertainty
A bank bailout from across the pond sent the stock market higher to start the week.
Time will tell if this bank boost is enough to save the overall financial markets.
Until the dust is settled traders need a game plan to work through the uncertainty that is similar to the financial crisis 14 years ago.
Bears in control as banks fail near, far
Bear traders remain in control of most areas of the stock market with bull traders hanging onto mostly the technology sector, according to Sam Shames, VicePresident of Options at Simpler Trading.
His recent trades have focused on fading the strength in the technology sector by shorting anything that isn’t technology.
“The main risk to that outlook remains hyper aggressive interventions by central banks,” Sam said. “Last week I did not expect the Credit Suisse debacle to start so quickly. How interesting that a bank failure in California can trigger a bank failure in Switzerland.”
European bank Credit Suisse was bailed out by its competitor, Swiss bank UBS, in a $3.2 billion takeover on Sunday. This followed the recent Silicon Valley Bank (SVB) collapse that forced the U.S. federal government to step in and guarantee that deposits would be honored. This was a big save for venture capitalists with considerable capital tied up in SVB.
This latest bank failure was surprising to many traders when comparing it to the 2008 financial crisis.
“What was unprecedented, following the 2008 playbook, is the speed of the reaction by the Swiss National Bank to offer a bailout,” Sam said. “It happened within hours. This same rescue operation in 2008 would have taken weeks.”
Traders can pull insight from this current bailout and how it applies to the current stock market.
“That tells me two things,” Sam said. “One is that whatever is next will likely play out much faster than in 2008 and central banks may be even more aggressive this time. Given the charts – with the yield curve as the North Star – and the 2008 playbook, I have to believe this is still a ‘sell every hopeful bounce’ market.”
Traders need to expect continued central bank attempts to stave off further bank failures and be prepared for sudden and possibly significant market moves.
“Traders should fully expect multiple interventions and none of them will work,” Sam said. “We are still far too early in the game. It won’t be easy because central banks will bark and bark to scare everyone into submission that they have control of the situation, but we know they no longer are in control.”
Can Fed handle inflation, bank failures?
The Federal Reserve (Fed) may be facing more than it can handle as it tries to lower decades-high inflation with rising benchmark interest rates, and now bank failures.
“Remember, the Fed is a one-legged man in an ass kicking contest,” Sam said. “The only way
out is for them to print a bunch more money – inflation may limit this option – and then when that doesn’t work, they will change the rules of the game. It’s too early for
Traders can put together a game plan to fight through the uncertainty.
“So, the only play left is to short all hopeful bounces back to daily and weekly resistance levels,” Sam said. “Remember also that day trading when VIX – Chicago Board Of Exchange (CBOE) Volatility Index (VIX) – is this high gives us the most amount of edge and optionality.”
The VIX peaked at just shy of 30 last Wednesday and was at 24 today. This was the highest level all year and flirted with the high of over 33 in October last year. Anything above 20 is considered high volatility and above 30 extreme volatility with heightened fear among stock market participants.
The volatility is what seasoned traders look for in the stock market.
“Nothing sounds better to me than waking up every day ready to attack whatever the market presents,” Sam said. “Yes, I have a heavy bearish bias but also remember that the biggest and fastest rallies happen in bear markets.”
Financial failures spur hope of lower rate hikes
Traders face a stock market landscape with many uncertain factors in play.
The Federal Open Market Committee (FOMC) meets Tuesday and Wednesday with an expected announcement of another 25 basis points interest rate hike.
And the market continues to digest the newly exposed fragility of the financial sector, particularly banking.
“Turmoil in the financial industry spread to other areas as fears of a global recession pushed economically sensitive stocks lower with oil, steel and aluminum all pulling back sharply,” said Mary Ellen McGonagle, Senior Managing Director of Equities at Simpler Trading. “Treasury yields dropped as well, as the markets signaled the Fed may need to begin cutting interest rates sooner than was thought in an effort to stem economic weakness due to volatility in the banking industry.”
In the market today, the Dow sprinted upward to 32,244.58 points to rise 1.20% (adding 382.60 points on the day). The Nasdaq notched higher to 11,675.54 points for a .39% gain while the S&P 500 bumped up by .89% to 3,951.54 points.
“The possibility of a drop in interest rates may be one reason for the Nasdaq’s healthy rally which was led by outsized returns in most of the leading mega-cap stocks,” Mary Ellen said. “The semiconductor and software groups also outperformed with a rally in both areas which pushed them into uptrends.”
Any upside movement hinges on the Fed meeting and announcement.
“We remain cautious on our near term outlook for the markets as we head into the FOMC meeting in the face of continued banking woes,” Mary Ellen said.
Resilient stock market faces another Fed test
Traders should consider that the stock market was put to the test and showed strength.
“While the markets were volatile last week, they showed surprising resilience despite the unfolding of a possible banking crisis,” Mary Ellen said. “That resilience will be put to the test this week when the Federal Reserve reveals whether they’ll keep raising interest rates at their meeting or take a pause to help stem turmoil in the markets that’s been due to recent bank failures.”
Traders must take note of what happens with the Fed this week.
“Also closely watched will be Fed Chairman Jerome Powell’s comments regarding the future path of interest rates,” Mary Ellen said. “Prior to the banking problems, it was noted that rates would need to move above 5% and remain there until inflation was tamed.”
While Fed comments and actions play out this week, traders can still look for opportunities while managing risk.
“We highlighted the new uptrend in the Nasdaq and signaled that most stocks on our list are in a buy zone,” Mary Ellen said. “We would continue to tread lightly however, as the Fed’s policy decision and the possibility of additional banking woes may keep volatility heightened.”