DOW at Crossroads

chart courtesy of www.stockcharts.com

The market received its much anticipated interest rate hike this week. The Federal Reserved opted to increase rates by 0.25% thereby ending an historic period of easing. The market reacted with a powerful rally upon the news announcement. The next date saw sharp declines among broader markets. This historic tightening occurred while the rest of the world is focused on easing rates as an attempt to stimulate growth.

There are 3 reasons why interest rate tightening will have a negative effect on markets:

1. An already strong US dollar will be made even stronger. This will be a negative for corporate earnings of the US multinationals. And their products become less price competitive with the rest of the world.

2. An already weak oil market will see prices drop even further since oil is priced in US dollars. There is an inverse relationship between the price of oil and the strength of the US dollar. The second tier oil producing nations are already struggling with deficits from weak oil prices. Their problems just got worse as oil is now trading below $40 per barrel with no relief in sight.

3. Banks already have starting increasing rates which they charge borrowers but they have not yet started to raise rates which they will pay depositors. The cost to purchase homes, cars, and other loan financed items just increased.

The junk bond market has already been selling off in preparation of the interest rate hike. Liquidity has essentially dried up for these instruments as investors have sold off. At least one fund has halted redemptions of their fund because of lack of liquidity. When this happens investors who need to raise cash are forced to sell off other assets that are more liquid. Also the issuers of these high interest paying instruments will be under stress as they will have to pay even higher rates in order to refinance their debt. This same type of thing happened at the beginning of the Financial Crisis in 2009. It is too early to tell how this will affect the broader markets but most assuredly it will be negative.

Don't believe the so-called experts who are essentially saying "Take your medicine, its good for you." The Fed has painted itself in a corner. Do they keep raising in order to "normalize" rates? even when the rest of the world is still easing? Or do they sit tight and do nothing. Worst of all, do they have to reverse their position as the above consequences take effect. Most money managers have not seen a rising interest rate environment.

The above chart shows how the DOW is now sitting at major crossroad levels with its moving average. One may simply refer to the IBM chart posted last week for a hint on where things might go from here. As one reporter last week put it, "the last two cycles of interest rate tightening did not end well for the US economy."

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