Before we get started, I want to welcome the +39 subscribers who signed up for the Let’s Analyze newsletter in the last week! If you want to join our community, make sure to sign up here:
I write a lot about the "market consensus."
The “consensus” in investing is the prevailing opinion of the investment community at any given time.
Keeping track of the market consensus is useful because it reflects the collective wisdom of a broad range of investors.
But you don't follow consensus to copy it; you follow it to strategically bet against it.
Because if you want to beat the market, you have to hold out-of-consensus opinions.
Recession? What Recession?
The market is looking a bit euphoric.
After blowout earnings from Microsoft (MSFT), Meta Platforms (META), and Alphabet (GOOGL), the “mega cap” tech stocks have staged an incredible rally…
…but under the surface, things aren’t as rosy. For instance, one indicator I watch closely is market breadth.
The easiest way to understand “breadth” is it’s the number of stocks rising and falling at any given time.
For example, if the S&P 500 is rising but the number of stocks participating in the advance is limited, it may be a sign that the market is overbought and due for a correction.
And right now, breadth is nearly non-existent.
The Weakest Rally in History
Analysts at JPMorgan estimate the current rally is “by some measures the weakest ever.”
For instance, Microsoft and Apple alone account for 2.3% of the S&P 500’s 8% gain this year. The two companies also make up a record 13% of the index — the most ever for the top-two stocks.
Much of this rally - particularly for Microsoft shares. - is due to optimism over artificial intelligence. Companies associated with this trend have generated $1.4 trillion of market capitalization this year alone:
Market breadth is clearly lacking during this rally as it’s been driven by only a handful of large tech stocks.
And next week’s Federal Reserve meeting could further complicate things.
Betting Against the Consensus
The Federal Reserve has a major meeting on Wednesday.
Known as the Federal Open Market Committee (FOMC), the central bank will reveal their plan for interest rates and their assessment for the economy.
The FOMC is often a market-moving event. And I don’t expect this meeting to be any different.
Right now, investors are expecting the following to happen at Wednesday’s FOMC:
The Federal Reserve will hike interest rates 25 basis points
The Federal Reserve will announce they will not hike any more after this meeting
And this isn't a hunch; all you have to do is look at the futures market for the Federal Funds Rate (FFR).
The futures market for the FFR represents expectations of what the Federal Reserve will do with interest rates at some point in the future.
And right now, the futures market expects the Fed to stop hiking in May...
...with rate cuts expected in October. And not only is the market pricing in rate cuts, it’s expecting 2.0% - or 200 basis points - in cuts.
That is by far the most Fed cuts the bond market has priced in since the 1980s:
A Fed pause and subsequent rate cuts are the current market consensus.
And I'm not so sure I agree with it.
Using Asymmetry To Your Advantage
When everyone is thinking one direction - like the Fed will only raise 25 basis points - that idea is said to have asymmetry.
Asymmetry is when the potential risks and rewards of an investment are not equal. In other words, the potential gains from an investment may be much higher than the potential losses.
Right now, there is not much upside thinking the Fed will hike 25 basis points. If and when that happens, the market will likely be flat on the news.
But if the Fed hikes 50 basis points or says the will continue hiking after this meeting, there is significant downside as nobody thinks that will happen.
This is despite Fed officials like New York President John Williams saying publicly rates will go higher:
And considering the current rally is on weak footing, the market looks vulnerable.
Do With This What You Will
There is no way to know for sure what will happen.
But what I do know for sure is this trade has asymmetry and options are dirt cheap, which is why I’ll be opening a trade to profit from this setup tomorrow (you can get all the trade details here).
Because my goal with this newsletter is to help you see what’s coming around the corner and - ideally - how to make money off it.
And right now, it looks like Jerome Powell is waiting on the other side of that corner ready to kick the market’s ass.
So make sure your portfolio is ready.
Stay safe out there,
Robert
The Biggest Risk for Stocks Today
I believe you are spot on here and I am likely to buy a broken wing butterfly on the SPX in the put end of the spectrum, pinned on a downside multiday VWAP ledge.
The probability that the market will sell off than rally later in the week, appears higher when one puts a bit of thought to it, just as you have. Yet it feels that not that many people are currently paying that much attention.