Stocktake: Message from Fed was hawkish, not dovish

Fed message was hawkish, not dovish This year has been dominated by chatter as to when the Federal Reserve would finally raise interest rates. Now that the inevitable rate hike is finally out of the way, the question is: what's next?

Markets cheered last Wednesday’s hike, with most commentators seeing it as a dovish hike, but Thursday’s subsequent sell-off indicated investors were having second thoughts. Some ambivalence is understandable.

The dovish argument largely rests on the fact that the Fed twice referred to further hikes being introduced at a “gradual” pace.

However, the Fed’s message was hawkish in other respects. First, not one board member dissented, with all agreeing a rate hike was appropriate.

More importantly, the Fed “dot plot”, which reveals officials’ expectations for future rate policy, was unchanged, with four rate hikes pencilled in for 2016. Markets expect just two hikes, with none forthcoming until June.

Markets are right to be sceptical. Back in 2012, the dot plot indicated rates would rise in early 2014, and market expectations have been much more accurate than the Fed’s in recent years.

Still, the absence of dissent and the unchanged dot plot is hardly dovish. The Fed could have narrowed the gulf between official expectations and market expectations, but chose not to do so. If that gulf persists, periodic bouts of market volatility can be expected in 2016. Sell too early or too late? The US bull market began in 2009 and is still intact as we face into 2016.

Many worry a bear market is overdue, but there is always the risk of selling too early and missing out on further gains. No one catches the exact market peak, so which is better: selling too early or selling too late? It depends, says Merrill Lynch in its 2016 market outlook. In six of the last 12 market cycles, it would have been more profitable to sell six months before indices peaked than six months after.

On a 12-month basis, however, the end of the bull market tends to offer bigger returns than the losses over the subsequent 12 months. On a 24-month basis, the “sell too late” trade is better in more than 80 per cent of cases. Although the best returns tend to come in the last year of a bull market, investors who sold within a year of the peak invariably get the opportunity to buy back in at cheaper prices during the subsequent bear market. This has been the case in every cycle in the last 80 years, notes Merrill. Still, buying back in is easier said than done: how many investors had the guts to buy in late 2008 or early 2009?

No one knows what 2016 has in store, but it's safer to remain invested rather than fretting about a possible market peak. Fund industry Christmas letter It has been another lousy year for hedge funds, but that hasn't stopped them enjoying lavish end-of-year parties.

Billionaire John Paulson (inset), many of whose funds have lost money this year, held a holiday party at a "slick rooftop lounge" in Manhattan, Reuters reported last week, while other hedge funds hosted parties featuring performances from Andrea Bocelli and Katy Perry.

The Reuters report brought to mind a quietly vicious post from the Evidence-Based Investor blog. Entitled A Christmas Letter from the Fund Industry, the satirical letter cheers the fact that “pay and bonuses continue to soar” despite “another year of dismal returns”.

“It just remains to thank you, our clients, for your continued support and, more importantly, to thank the army of advertisers and PR consultants, without whom this whole charade would have been exposed long ago.”

Harsh? Perhaps, but more than a little true. Yes, there is a Santa rally Santa may be about to boost stock markets. According to the Stock Trader's Almanac, stocks have historically enjoyed a "short, sweet respectable rally" (averaging gains of 1.5 per cent) during the last five trading days of the year and the first two trading days of the new year.

Nor does Santa confine himself to Wall Street. Earlier this year, a Journal of Financial Planning paper analysed Christmas returns across 18 indices in 16 different countries, including non-Christian ones.

In every single case, higher returns and lower volatility were evident.

The title of the paper says it all: Yes, Virginia, There is a Santa Claus Rally: Statistical Evidence Supports Higher Returns Globally.