There’s Presents Beneath That Coal By Michael Salvatore, Editor, TradeSmith Daily In This Digest: - The hawkish Fed re-pivot throws cold water on the Trump trade…
- But it could be reversing today…
- S&P 500 breadth worsens at a six-year extreme…
- All this volatility has me thinking about one great TradeSmith tool…
The Federal Reserve turned hawkish this week… If you checked your portfolio toward the end of the session on Wednesday, you probably let loose a few “excuse my French” type words in response. From the time the interest rate decision and the Fed’s updated dot plot were released at 2 p.m. Eastern, the S&P 500 fell more than 3% into the close. The rate-sensitive small-cap sector fared even worse, falling more than 5% and completely erasing the gains we’ve seen since the start of November. Here’s a chart of all the major benchmarks’ performance from the start of November: 
Small caps were a runaway leader just six weeks ago. Now they’re flat. Such is the way things go when the U.S. short-term lending rate is the most watched number in the world… behind U.S. inflation. That brings us to the dot plot. There were some major adjustments to Fed officials’ inflation expectations and rate expectations through next year: 
There are some meaningful changes here. For one, the Fed thinks GDP growth will be higher at the end of 2025 than it previously expected. It also expects unemployment to improve. That’s the good news. The bad news is it also expects substantially higher core PCE (personal consumption expenditures) inflation at 2.5%, where before it saw a rate of 2.2%. As such, it considers a federal funds rate of “3.9” (translation, a range between 3.75 and 4) to be appropriate for year-end 2025. That means the Fed predominantly thinks there should be only two rate cuts next year. There’s no better way to say it: The central bank is all over the place. Back in September, the Fed went big with a half-point cut, effectively declaring, “Mission accomplished.” Now it’s pulling back and saying inflation will remain well above 2%, and fewer rate cuts are warranted… much as we’ve been saying in these pages. If September was a dovish pivot, then this past meeting appeared to be a hawkish “re-pivot”… But a good inflation number today could change everything… again… I’m writing this on Thursday, so I can’t yet comment on the core PCE number coming out today, Friday. But what I can say is that if the number comes in light, we should see a stunning reversal of fortune. Stocks sold off Wednesday in such knee-jerk fashion because investors feared precisely what they feared in 2022 – a long regime of high inflation, and higher lending costs to fight it. If we get some evidence that inflation is still headed in the right direction, it seems likely to me that a lot of the damage done this week could reverse. Especially when you look at the stats behind such stunning single-day drops. Make no mistake, you’re still reading TradeSmith Daily. We’ll have our hunches… But then we’ll test the data to see how right they may be. All of the major benchmarks slid at least -2.5% on Wednesday’s Fed news. So let’s test which of the benchmarks makes the best short-term recovery (five trading days) after such a big single-day loss. 
These are some encouraging results, if you ask me. No matter which area of the market you look to buy, the odds are much better than a coin flip. But the runaway strongest sector is the S&P 500, with more than 69% of the 124 times this has happened resulting in a higher price five days later. Tech stocks (QQQ) are also noteworthy, with the highest average trade result of 1.12% and the highest average winning trade of 4.21%. Small caps (IWM), with the second-highest number of instances where this has happened, have overall the worst results for this idea. The win rate is just under 60%, and the average trade is just 0.77%. So if you’re going to make a big bet on this slide, you want to look at large caps. The bag Santa brought may look to be filled to the brim with coal. But the patient and the bold who look a bit deeper might just find a few presents. Especially when breadth is in such a rough shape… Take a look at this chart of S&P 500 stocks trading below their 50-day moving average (blue line), with a Relative Strength Index (RSI) of that measure on the bottom (purple shading) and the SPDR S&P 500 ETF (SPY) overlaid on top (pink line): 
The RSI, as regular readers know, is a measure of overbought and oversold conditions. At least that’s what it means when you’re looking at stock prices. Today, we’re comparing it against the percentage of stocks in the S&P 500 trading in bullish technical conditions, so it acts more like a measure of how quickly those conditions have changed. The RSI of S&P 500 breadth is currently at a nearly six-year low. The last time breadth worsened this quickly was back in 2018 – again, as a result of Fed policy spooking the markets. But I’ve also plotted times where breadth rapidly worsened since then. Mid-2019, the pandemic crash in 2020, two blips in 2021, and the 2023 and early 2024 corrections all saw action like this. In every instance, stocks were higher six months later. That should reinforce just how knee-jerk this sell-off was. To my mind, this reaction was a big buying opportunity for the year ahead. The rarity of such worsening conditions, and how they tend to not be the start of longer-term bearish trends, should comfort those who are sweating this week’s decline. There’s another way to harness volatility… While we wait for brighter days in the stock market, at least we can turn these volatile conditions to our advantage. On Monday, we’re releasing our next round of Weekly Income Opportunities – and at times like this, the trades help you collect $850… $1,260… or even $1,960 in as little as a few days;. Jan. 24, 2022, for example, gave subscribers the chance at a $3,726 profit. And if that particular day doesn’t ring a bell, I’m sure you remember what 2022 was like in general. We were already down 8% on the S&P 500 in just the first three weeks. So to be bringing in a quick profit like that is quite a comfort. Our Weekly Income Opportunities continue to throw you a lifeline during bear and bull markets, but especially when volatility spikes like this. Go here to see what we have in mind and get on the list for Monday’s trades. To your health and wealth, 
Michael Salvatore
Editor, TradeSmith Daily | 
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