Today, the Federal Reserve kicks off its two-day meeting on interest rate and other policy matters.
The meeting will be critical to investors’ short-term and long-term confidence in the U.S economy and global markets. By now, you’ve likely already heard a lot of speculation about what Fed Chair Jerome Powell’s team must decide.
And, over the next two days, the financial media will bombard you with big words.
They’ll talk about “transitory” inflation elements in the economy (This quoted term means that the Fed believes inflation is not permanent).
They’ll talk about “monetary policy.” (This policy is what the central bank manages in terms of interest rates, the buying and selling of bonds, and its other efforts to maximize employment and control inflation.)
Pundits will even talk about “tapering.” (This term means the eventual decision by the Fed to stop buying bonds and allow the economy to stand on its own.)
But the media owes you more than chatter about the central bank.
They should explain what Wall Street’s largest institutions are doing ahead of this meeting.
While retail investors are putting their money to work…
Institutional investors are moving to cash quickly.
Here’s why.
A Pullback or a Buying Opportunity?
“Smart money” is a term that many people use to talk about institutional investors.
But are they that smart? It depends on whether you let them forget the financial crises of 2000, 2008, and 2020.
These investors matter, not because of their intelligence, but because of their muscle.
Large financial institutions like hedge funds, private equity groups, pension funds, and banks like Goldman Sachs influence confidence in markets, funds, and individual stocks.
When they put a lot of money into a specific company, many other investors will follow.
And if they pull out of a company, then you’ll see large drops as well.
What’s very interesting is that these institutions are not buying stocks.
UBS Equity Derivatives’ new report noted that institutional investors have added to their cash positions in 14 of the last 17 weeks. These investors have now built a $397 billion position in cash.
What does this tell us? Well, these firms could be looking for clients out of the market; they might be looking for a potential pullback after the Fed’s announcement; or they might be looking to profit from cash.
JPMorgan is generating headlines this week on news that it is sitting on $500 billion in cash.
CEO Jamie Dimon recently said that the bank has been increasing its cash position.
“We’ve been effectively stockpiling more and more cash, waiting for opportunities to invest at higher rates,” he said during a recent Morgan Stanley virtual conference. “So our balance sheet is positioned (to) benefit from rising rates.”
If interest rates rise, the company could be looking to use its stronger dollar to purchase assets. JPMorgan is expecting to have one of its best trading quarters ever. It expects to make roughly $6 billion from its bond and equity trading divisions.
While institutions are moving to cash, however, U.S. retail investors are putting their money to work.
In the same institutional report, UBS said that retail investors put another $5 billion into the markets last week. Investors continue to actively trade meme stocks, buy long-term positions in FAANG stocks, and other positions. In the previous 20 weeks, retail investors have poured about $98 billion into the markets.
Retail investors have been far more active than last year, thanks to the uptick in stimulus money. First-time traders have speculated on Reddit stocks, out-of-the-money (OTM) options plays, and other frantic trades.
This trend is expected to continue. Retail investors are looking for action and fast profits.
But the institutions are acting with a much more guarded approach to the long-term impact on the markets and the Fed’s role. Institutions might sit on the sideline with more cash, looking for new buying opportunities.
Or, they might be looking for the U.S. dollar to find its bottom and aim to benefit from a rising U.S. dollar.
Remember, Cash is a Position
One important thing to remember is that cash is a position. It is a tradable asset like any other commodity in the market. So, it’s worth considering that institutions are sitting on cash because they expect it to rise in value.
Tomorrow’s Fed meeting will be critical due to the ongoing concerns about inflation in the U.S. economy. Although the Fed says that inflation will be temporary, we have witnessed two straight months of historical upticks.
Today, we saw the May Producer Price Index (PPI) rip to a 6.6% increase over the past 12 months. That is the most significant annual increase on record and a sign of huge price jumps across U.S. supply chains.
In addition, the Consumer Price Index hit its highest level in May since 2008.
When it comes to the Federal Reserve raising interest rates, it’s a question of “when” and not “if.” Keep in mind that we’ll need to see some changes in language from the central bank before a sudden increase.
Any chatter about increasing the benchmark rate by the Fed before its targeted date in 2023 could spur a rush to bonds and a downturn in growth stocks. We would look for the yield curve to rise, with increasing expectations for the Fed to take action sooner than later.
If the U.S. economy continues to heat up and the Fed takes action on rates, the U.S. dollar can experience a quick revival. This is something that our Chief Research Officer, Justice Clark Litle, predicted earlier this year. So, if you haven’t understood the impact of dynamic economic growth, take a look at what could soon be in store for the dollar.
Investors should pay close attention to what the institutions are doing with their cash. If we see strong buying into specific sectors, that could push several side-trending stocks into the Green Zone and thus create new buying opportunities.
But if we see more cash pulled from the market, don’t fret. Stay where you are with confidence and ride out any storm with the signals of TradeSmith Finance. Use your trailing stops accordingly and look for new opportunities in stocks that might benefit from higher rates and higher inflation.
We’ll talk more about knowing how and when to exit a trade this week.
Enjoy your day,
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| Keith Kaplan CEO, TradeSmith |
