Stop betting on a Fed put and accept that the cost of capital will rise

Stocks rebounded on Wednesday, but do you think the gains were enough to distract anyone from Tuesday’s bloodbath? I do not think so.

We all know that it’s how the market reacts to news that counts, not the actual numbers in an individual economic report. And based on Tuesday’s slump after August’s Consumer Price Index (CPI) report, we know two things. Traders were far too optimistic in their estimate of lower inflation. More importantly, Wall Street continues to ignore every Fed official who insists that rates need to rise and stay high for an extended period. Simply put, investors need to stop betting on a Fed put and start accepting that the cost of capital will continue to rise for the foreseeable future.

The one aspect of these rate hikes that continues to surprise me is that no one seems concerned about how quickly the cost of capital is changing. While most investors are unsure whether the next hike will be 75 basis points or a full stick, there is relatively little discussion about the likely impact of these hikes on the economy over the next eight to next 12 months. With stocks down sharply from their 2021 and early 2022 highs, Wall Street analysts haven’t begun to cut earnings estimates for most companies.

As for indices, most traders I spoke with on Wednesday were expecting minor stabilization in stocks. But of those active traders, most are betting on a break from Tuesday’s low. While Tuesday’s decline was painful for bulls, almost all of Wednesday’s trading occurred within the excess downside created when selling between 2:30 p.m. ET and 4:00 p.m. ET on Tuesday. Traders will likely want to see a bearish excess (a wick lower on a candlestick chart) below the Tuesday and Wednesday lows to feel confident that a tradeable low has been found. I don’t believe we found that.

Ultimately, Tuesday’s drop destroyed many rankings. Until I see a better setup above the 21-day exponential moving average and the volume-weighted average (VWAP) price anchored at the mid-August high, I’m mostly sticking to trades daily.

If you’re looking for something to be optimistic about, look at the ARK Innovation ETF (ARKK). While ARKK has been crushed over the past 18 months, it has outperformed all major ETFs over the past few days. This outperformance is something traders should watch.

Receive an email alert each time I write an article for Real Money. Click “+Follow” next to my signature for this article.