The Next Stock Selloff Could Lead To a New Buying Opportunity

This week is a pretty big one for financial markets. Both the US Federal Reserve and the Bank of Japan (BOJ) have interest rate meetings scheduled.

It could prove to be somewhat of an inflection point. My feeling is that both central banks will try and ease off their perpetual promises of unlimited and undying support for financial markets.

Because if they don’t do it now, they may never get another chance.

Let’s look at the BOJ first. The Japanese economy is far and away the world’s biggest basket case. Absolutely nothing that the BOJ does has any lasting effect on the economy. That’s because the Japanese simply refuse to genuinely reform their economy. They simply expect monetary policy and government spending to do the job.

At their last meeting, in late July, they disappointed markets by not pushing interest rates even deeper into negative territory. This lack of action got the market thinking that the BOJ was out of ideas.

In February, the bank made interest rates negative on some commercial bank deposits, and its ongoing buying of Japanese government bonds (JGBs) pushed yields into negative territory, too.

The BOJ now owns over one third of the JGB market. It is the market. This action led to some criticisms about the effectiveness and unintended consequences of negative interest rates.

Against this backdrop, the BOJ comes into this week on a hiding to nothing. They either have to come up with something new and audacious, or they will disappoint the market.

The US Federal Reserve is also in a spot of bother. They desperately want to raise rates. They want to move interest rates higher before the next economic slowdown hits…but they don’t want a rate rise to cause the slowdown!

Recent economic data released in the US has been weaker than expected. But the labour market remains healthy and there are signs of a pick-up in inflation. This gives the Fed the ammunition it needs to raise rates.

While I doubt the Fed will raise rates this week, I think it is more likely that they will prepare the market for a definite move in December. It really is now or never for the Fed.

They’ve been threatening ‘interest rate normalisation’ for years. All they’ve managed so far is one 25 basis point hike, in December last year. And look what happened after that…

The US dollar surged, China and emerging markets came under heavy pressure, and global stock markets crashed. It was only when the Fed took consecutive rate rises off the table, and China injected more stimulus, that markets stabilised.

This gives you a few clues as to what the Fed will do now. That is, if they do communicate that a rate rise looks likely for December, they should emphasise that they will do nothing for a while thereafter.

If they have any brains, or a feel for the market, there should be none of this ‘three rate hikes in 2017’ business. That will put the fear of God into the market, and you’ll likely see some pretty heavy selling.

As it is, I think you’ll see some selling over the next few weeks anyway. The Fed has lured global markets into a false sense of security. The prevailing view is that the Fed has a triple — and not a dual — mandate. That is, they’re concerned about the labour market, inflation, and asset prices.

While that certainly seems to be the case, it’s not. Because if the Fed ignores a tightening labour market and rising inflation, and shows too much concern for maintaining high asset prices, the market will have contempt for it, and that is something the Fed will not allow.

As I said, it’s now or never for the Fed to hike. This business cycle is already mature in terms of historical economic expansions. The probability is increasing that a slowdown is approaching, no matter what the Fed does.

They surely know this. They don’t want to be the Fed that stood there, mouth agape, holding interest rates down through a whole business cycle, leaving absolutely nothing in the tank to fight the next recession.

At least, I’m pretty sure they don’t want this reputation. So this week isn’t looking like it will be a good one for markets. And that goes for the next few weeks. Markets are simply not positioned for a tough-talking Fed.

The good news is that any sharp selloff will more than likely be a buying opportunity. Because, as much as the Fed doesn’t want to be influenced by the market, a 10–20% decline in the S&P 500 would certainly get them sitting up and taking notice.

As I’ve written before, the Fed has created a monster, and it can’t go from feeding it to letting it starve in a matter of months. So have some cash waiting on the sidelines, you may get a chance to deploy it profitably in the next few months.

If you’re after some investment ideas, check out the latest presentation from my mate Sam Volkering. Sam is the editor of Australian Small-Cap Investigator, which focuses on stocks at the smaller end of the market offering big potential rewards.

Sam has been in cracking stock-picking form this year, so I strongly suggest you have a look at his latest idea.

Cheers,

Greg Canavan,
For Markets and Money


Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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