There is something strange going on: traders lack fear in this bear market. It has me quite puzzled. Perhaps the shock from a nonstop drubbing these past few months has numbed everyone? Four of the first five months of the year have shown negative returns. But that doesn’t quite explain it.
Traders lack fear in this bear market
After such a long bull market, you’d think the bear market alone would have instilled fear in traders. They were conditioned to always buy the dip. Why should they fear a big drop? If the market tanks, the Fed will come to the rescue. They always have.
But that’s not where we are right now. The Fed is on a campaign to stomp out high inflation; they have already raised interest rates twice with more hikes on the way. The futures market is pricing in monster rate hikes over the next few months. We could see the Fed Funds Rate move significantly higher from where it stands today – from 0.75% all the way up to 2.5% by September.
If there is anything more poisonous to equities than rate hikes, I want to know about it. Higher interest rates are meant to cool down the economy and slow spending, which will affect profits. So why do traders not seem concerned?
The markets seem to be pricing in the hikes, but they are not pricing in the potential impact on the economy. Inevitably, the economy will take a hit. But volatility in the markets is low, as if nobody really minds the higher rates. At some point that attitude will change.
Protect your portfolio for the day when fear kicks in
Today, buying protection is pretty inexpensive. I strongly advise you to cover your tracks by buying some index puts and holding plenty of cash. When fear does rise sharply (as it did for a time on Friday), those index puts and your cash will help shield your portfolio from frantic selling.
