The Federal Open Market Committee cut interest rates again on Wednesday and reduced the number of interest rate cuts next year. That decision dismayed investors and triggered a run for the exits in the stock market. Will this government Grinch decision ruin the chances of a Santa Claus rally?

 

Wall Street labeled the central bank move a "hawkish cut." Prior to the meeting, most investors were expecting that the Fed would pause after this month's rate cut of 25 basis points. Given that events unfolded as expected, why did the Dow lose over 1,000 points in two hours?

 

Inflation is the short answer. You may recall in last week's column I commented that stock traders were choosing to ignore the back up in the  rate of inflation over the last three months. It is something that has concerned me for months as readers know. I remarked that others were so focused on the wonderful promise of a second Trump administration that inflation just didn't seem to be a problem.

 

That changed this week. The Fed finally admitted that their inflation forecasts for this year were not coming through. Several members of the committee began to back away from easing further.

 

In the Q&A session after the Fed meeting, Chairman Jerome Powell made it clear that their inflation target of 2 percent may not happen for another year or two. Until it does, he warned we should expect further declines in interest rates to occur at a slower pace. As a result, the FOMC has halved the number of rate cuts they expected to approve in 2025 from four to two and maybe not even that many.

 

His decidedly negative remarks immediately took the wind out of the market's sails. The Dow was not alone in its fall. Both the S&P 500 and NASDAQ declined  2-3 percent as well. Thursday saw what I would call an anemic dead cat bounce and on Friday the markets rebounded.

 

Friday was another one of those triple witching days in the options markets which occur four times a year. Given the sheer dollar value of these occurrences, markets can be unusually volatile. A total of $6 trillion in options of all kinds expire Friday. In addition, the S&P 500 Index and other indexes will be rebalanced as well. This rebalancing can cause significant shifts in trading volumes and volatility as well.

 

 All of this is occurring in a week when the Fed triggers an overdue pullback in the averages. One of the clearest signals that something was amiss was breathe. Breathe is the number of stocks going up versus the number going down. Negative breathe had been increasing for the last 14 sessions as just a handful of stocks were keeping the markets positive. It is usually a sign that a pullback is coming and sure enough we are in one now.

 

My mistake was failing to take action and instead counting on the seasonal factors to win out over breathe. Does that mean the Santa rally will be skipping the U.S. market this year? Not necessarily. Although I now believe we could fall further, it does not have to happen next week. We could bounce next week into the New Year before heading lower again.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.