One of the most important lessons we learn as traders is that we must be suspicious of the crowd.
When everybody is expecting the same outcome, chances are the opposite usually happens.
So here are three surprises we should expect this week. This could turn out “nasty” if you’re on the wrong side of the market.
1) The Fed “Septaper” Surprise: No Crash
The big news event of this week is happening this Wednesday 18th September when the Federal Reserve concludes its next policy meeting.
Everyone is waiting to hear whether the Fed will begin “tapering” – i.e. reducing its $85 billion dollar a month bond buying program.
Remember that since the Fed started this bond buying program (or “QE”) in November 2008 the stock market has risen by 96%!
The question is not so much whether the Fed will taper this Wednesday (I personally believe that it will). The real question is how the market will react if the Fed does taper.
Almost all the traders that I have spoken to in the last few weeks have said that they are expecting the stock markets to “crash” or at least fall pretty hard, if the Fed decides to taper this month.
The truth is that the market has known about the possibility of tapering since May of this year. So there has been plenty of time for the market to “price in” what the Fed might do this month.
In other words, since May, the market has had time to get used to the idea of a taper either this September or in December.
So I think that any traders expecting a crash or sudden fall in stock prices if the Fed announces tapering this Wednesday will be very disappointed.
In fact, quite the opposite may happen.
As one market strategist at Prudential said: “If the Fed’s announcement (on the size of tapering) roughly matches expectations, look for stocks to continue to “cautiously rally”.
I know. It’s crazy. The stock markets are over-valued and in need of a correction. But we know markets can stay irrational longer than investors can stay solvent.
Right now the strongest market is the Nasdaq. The Nasdaq has been leading stocks higher – see this chart:
As the Nasdaq continues to plough higher, expect it to drag other stock indexes with it kicking and screaming.
Remember, September may still be a bumpy month. Even if we are lucky enough to get a 10% correction or more, that will be a buy opportunity.
2) The Japanese Yen Surprise
One of the least talked about markets in financial papers and media seems to be the Japanese Yen.
Few people seem to mention the strong negative correlation between the Japanese Yen and the US stock markets.
A lot of this has to do with the Japanese efforts to rescue themselves from deflation by devaluing the yen and thus inflating its economy.
As you can see from the above chart, that process worked for a while from December to May of this year as then yen fell by 18%. The Japanese began to see a rise in sale prices.
If the yen continues its downward decline (as can be seen by the break below the wedge pattern on the chart), then expect US stock prices to be pushed higher as well.
3) Bonds “last breath” Surprise
If you missed your chance to short bonds this year, here is where you may get your next best chance.
Right now, I believe we are at the beginning of a long term bear market in bonds.
Since May of this year, bonds have fallen approximately 12% for reasons which we explained earlier: the possibility of the Fed reducing its bond buying program (or “taper”) this September.
We have been short on bonds since May and I consider them to fall further in the months to come.
But there is a short term surprise which we should prepare for – and this could catch a lot of people out. Take a look at this chart of bonds:
The chart shows bond prices in the middle of a descending channel. These kind of patterns usually break to the upside.
Remember that traders who are already short on bonds may experience a “short squeeze”. This happens when they are forced out of their short positions by a sudden rise in bond prices.
I believe that if the Fed decides this Wednesday to begin tapering, any traders who start shorting bonds in expectation of a collapse on Wednesday will likely get slaughtered.
As I mentioned, markets have already “priced in” the possibility of a taper.
However, there are plenty of people who are waiting for another good opportunity to dump their bond holdings. That opportunity may come if bond prices rally to the next resistance levels at 136 and 138.
I’ll be looking to short bonds again if we can get to those levels. In the meantime, it pays to be patient and cautious.
Alessio Rastani is a stock market trader at www.leadingtrader.com