By the time this article is published, investors will know what the Federal Reserve has decided regarding the path of interest rates. Instead of a forecast, my goal is to offer a roadmap by which investors can chart a profitable path for their portfolio.

One thing is nearly certain, there won’t be an interest rate cut in the remaining days of 2023. Thus, if the central bank raises rates, the content here will serve as a warning for what may lie ahead. If the Federal Open Market Committee (FOMC) leaves rates unchanged, this article offers plenty of evidence to justify such a course.

Leave Well Enough Alone

There’s an old saying which wisely notes: “the enemy of good is better.” And when it comes to the actions of the Federal Reserve, there are many investors who are quietly invoking it in hopes that the next move from the central bank is to leave interest rates unchanged.

The Fed has made it clear that its next rate move will be influenced by economic data, while noting that it’s not likely to lower rates any time soon. On the other hand, both the stock and bond markets have been pricing in a rate decrease as early as March 2024 since October, when the market bottomed, as I humbly suggested just before the rally erupted.

Since then, inflation has flattened out. The most recent Consumer Price Index (CPI), Producer Price Index (PPI) numbers remained on the stable track. This suggests that the Fed’s eleven rate hikes since March 2022, which took the Fed Funds rate from zero to 5.25%, have slowed the rate of rise in inflation.

What’s missing is evidence that a sustained decline is coming. All of which brings me to the potentially dangerous decision which faces the FOMC at its 12/12-12/13 meeting, which is whether to raise rates one more time to bring about that convincing decline in rates.

I hope they don’t. Instead, I hope the central bank continues its “higher for longer,” and “data dependent” stance on rates, as another rate increase could well push the economy into a full blown recession.

The Markets Agree

While I’m a pragmatic investor, I’m no fan of interest rate increases, especially those which have the potential to cripple markets and economies. Yet, it’s important to gauge their effect on both.

Consequently, look no further than the action in the financial markets in response to CPI and PPI, and by extension to what the Fed seems to have accomplished with its rate increases. Starting with the bond market, we see the U.S. Ten Year Note yield (TNX) has entered a consolidation phase after its torrid decline from its October peak at 5%.

This is as bullish a chart pattern as one could hope for from the inflation hawks in the bond market. The fact is, that TNX has fallen nearly 25% from its October highs and is now consolidating. The key chart point is 4%. A move below this yield, after the Fed’s announcement will change the investment landscape for the foreseeable future. A reversal above 4.3% won’t likely play well in the stock market.

Stocks are also in a constructive trading pattern. You can see that in the slowly emerging breakout in the S&P 500 index (SPX). Worth mentioning are two very bullish technical findings related to SPX; Accumulation/Distribution (ADI) is rising along with On Balance Volume (OBV). Combined, the rise in these two money flow indicators indicates that short sellers are not finding fertile ground (ADI), while buyers are still building positions (OBV).

In the short term, the crucial support level for SPX is 4550. A break below that would likely take the index to the 4400-4500 support band. Further weakness below that point would be very concerning.

Value Investors Bet on the Fed

Some in the market are concerned about the technology sector running out of gas. Of course, they are referring to the pullback in the AI sector. But here’s the thing, AI may sell papers, but momentum runs always end badly. And the AI momentum run is no different.

So, while momentum stocks often deliver excellent returns, as long as investors don’t get greedy and are able to get off the wild ride before the inevitable crash, the world of value investing is different. There, instead of glitz and glamour, there is a need for detailed analysis of what’s under the hood in each individual company and sector.

Here are two groups, which against all odds, have recently benefited from positive money flows from value investors.

First is the financial sector, as in the Financial Select Sector SPDR Fund (XLF). Note that the value opportunity was created in March, as investor fear hit a fevered pitch during the Silicon Valley Bank scandal and the ensuing stealth bailout of the banking system via the Fed and the FDIC.

Since then, XLF is up a nifty 25 percent. Moreover, it looks as if the ETF is in the early stages of what could be a momentum run as it has now moved decidedly above the $35.50 resistance area. The rally in being fueled by a similar dynamic to what we saw in the S&P 500, above – short sellers leaving the scene (ADI) and buyers coming in (OBV).

The transportation sector, as in the SPDR S&P Transportation ETF (XTN) is also defying the odds, having deftly moved above its 200-day moving average with ADI and OBV confirming the move higher. Interestingly, the move is more reflective of the recently positive action in the airline stocks, which has resulted from the pullback in oil prices.

Yet, the value point in this sector was created by the implosion of the trucking industry, where bankruptcies, layoffs, and carrier closures have increased over the last six months due to the Fed’s interest rate hike cycle.

Where the two sectors meet, and where the value aspects of investing in these sectors coincide, is in the market’s expectations that the Federal Reserve is done raising rates. Thus, a negative surprise for the Fed will likely put a crimp on bot these ETFs, along with the stock market.

A Negative Surprise Could Kill the Rally and Push the Economy into a Recession

The U.S. economy is in a better position than China and Europe. But it’s not out of the woods by any means. The Fed’s anti-inflation crusade has clipped its wings. Recent headlines about U.S. GDP growing above 5% are mostly outdated, even if they are still being reported as current. A more current number is the Atlanta Fed’s GDP Now number, which currently calculates GDP at 1.2%.

Moreover, recent private payroll numbers (ADP) and layoff statistics (Challenger Christmas) suggest that the recent U.S. payroll numbers may be adjusted to the downside in January.

Recently, tech companies such as Spotify (NSDQ: SPOT) have announced sizeable cuts to their work force, while banks such as Wells Fargo (NYSE: WFC) have increased reserves to offset severance payments for future layoffs. Meanwhile toymaker Hasbro (NSDQ: HAS) announced layoffs for 20% of its workforce. In addition, as consumers tighten their belts, retail sales for the holiday season, other than online have slowed, while retail CEOs continue to sound cautious.

In other words, the Fed’s rate hikes have already slowed the economy significantly, without miraculously having pushed it into a recession; yet. From an investment standpoint, both the bond and stock markets seem satisfied with the central bank’s current progress.

Certainly, as anyone who buys groceries or anything else these days is well aware of, there is still plenty of inflation left in the system. Yet, it would be a huge disappointment to the markets, and to the economy, especially during an already challenging holiday season for consumers and the working masses, if the Fed decided to “improve” on what it’s already accomplished in its fight against inflation.

So, let’s hope the Fed left well enough alone on 12/13, at least for the rest of 2023. As the old saying goes: “the enemy of good is better.” If they didn’t, I suspect Christmas lights in the market, and elsewhere will be dimmer.

Keep an eye on the 4.0-4.1% yield area on TNX and 4550 on SPX after the Fed’s announcement and Powell’s (likely OMG) press conference.

Editor’s Note: Dr. Joe Duarte just provided you with invaluable investment advice. But we’ve only scratched the surface of our team’s expertise.

For market-thumping gains with mitigated risk, I suggest you also consider the advice of our colleague Jim Pearce, chief investment strategist of Personal Finance.

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