Dear Reader,
CJ here.
And we need to talk about this right now...
"Markets are on board with the Fed's 'higher for longer' policy, CNBC survey shows."
This is scary.
Now I don't care IF the headlines are telling you that the "markets are on board with the Fed."
In fact, I don't even care what Jerome Powell says on Wednesday.
Neither of those things matter.
Because this is the one number that does....
The market is literally in a must-win situation as we head into the first week of November.
Looking back, October will go into the books as a loser for stocks. That puts it on a three-month losing streak as stocks carried their late-summer weakness all the way into October.
Sure, we all expect to see some weakness in October, but as both Tom Gentile and I have stressed, October is historically the "comeback kid" for stocks the month averages a return of +1% over the last 20 years.
Now what?
Well, October's losses put the market into a must-win situation. Put simply, we should expect the first week of November to set the course for the next two months' trading trends.
This week is full of headlines. Jobs report, Apple earnings, and of course, the long-awaited decision from the Federal Open Market Committee (aka the Fed).
In my opinion, all three of these have huge implications for that first week of November. But the Fed's interest rate decision is likely to be the tipping point for the market's next 5-10% move.
Let's look at why and how I'm getting ready to trade the headline.
The market has been trying to trade independently of the Fed's persistent interest rate hikes through all of 2023.
We've heard Jerome Powell tell us that we're facing an interest rate environment that was going to be "higher for longer." Alas, equity traders ignored that message for much of the year, rallying stocks higher.
One very important market has heeded the Fed's forecast - the bond market.
Year-to-date, the bond market has followed a long-term bearish trend. Currently, the iShares 20+ Year Treasury Bond ETF (TLT) trades near its lows, some 13% lower than where they started the year. In comparison, the S&P 500 is still 10% higher than where it started the year, despite a 10% correction over the last few months.
That could all change on Wednesday - and the following five trading days - as the Fed's decision has the power to cast a cloud over the market, even if they hold rates steady.
Here's why...
At its current level, yields on the Ten-Year are hovering just under 5%. This, after we saw the same number tap 5% last week, had a pointedly bearish reaction from stocks. The 5% rate has revealed itself as a psychologically significant level that, if broke, will send a wave of selling throughout the equity markets as investors readjust their three- to six-month views on where interest rates are going.
The same reaction happened in July as yields were just below 4% ahead of the July meeting. The break above that psychological round-number sent stocks tumbling as the market "readjusted."
Now faced with a break above 5%, the market is set to do the same. Keep in mind that terminal rates are still expected to go somewhere around 5.55.6% (as demand for debt slows, issuance increases to satisfy the government's spending needs).
Wrapped up nicely, the Fed doesn't have to increase the Fed Funds Rate this time around in order to see rates go higher. The market is still adjusting to that "higher for longer" mantra.
OK, enough of the technical side, this is how I'm setting up my trading response to the Fed and it's simple!
Here's what to do...
Turn your TV off at 2:00 tomorrow. You only need to watch one number... 5%.
Now let's look at why on this chart:
A break above 5% on the $TNX over the next week is likely to cause another dip in the bond market while putting another round of selling pressure on stocks.
That will set the tone on Wall Street for a more difficult November, and possibly dash the hopes of a seasonally strong November or December.
Keep in mind that the market slides down a "slope of hope", and investors have been hoping for an end to weakness in the bond markets. Anything short of the Fed laying out a plan to drop rates in the foreseeable future will leave those hopes unfulfilled.
I'm waiting until Friday to trade this 5% number since we'll see earnings from Apple (AAPL) Thursday followed immediately by the October jobs report before the market opens on Friday.
My instruments for trading this are simple.
First, I will look to increase exposure to another 10% decline with the use of two inverse exchange traded funds.
The Proshares Ultrashort S&P 500 ETF (SDS) provides a simple way to add a hedge to my portfolio. This ETF increases roughly 3% for every one percent drop in the S&P 500. It allows for the use of trailing stops on profitable positions as well as stop-loss orders on the initial purchase, allowing me to identify my risk prior to the trade.
In addition, I will be utilizing slightly in-the-money put options on the Russell 2000 ETF (IWM). My expiration date for these options will be January 19, 2024, to allow the seasonal hope trade enough time to unwind over the next four to six weeks.
Of course, I'll be watching Apple's earnings closely as there are some heavy implications on the Nasdaq 100 (QQQ), which is likely to open even more opportunities as we work our way through this critical seven-day period.
I'll share thoughts on those headlines with you tomorrow.
Until then, I wish you the best trading success.
CJ
The post Why This Is the Top Headline You Should Know This Week... appeared first on Power Profit Trades.
About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.