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Why Rate Cuts Could Trigger a 'Sell the News' Event for Stocks

Close-up Of White Percentage Sign On Dollar Banknotes — Photo

Money and financial markets tend to operate on a forward-looking basis, often shifting by 6-12 months ahead. Most of the mega investors in the market today, from Warren Buffett to Michael Burry and Stanley Druckenmiller, have attributed some of their success to the ability to imagine the world shortly and then figure out which companies will do well in that version of the future.

Following this belief, the entire S&P 500, or at least the top holdings in the index, have traded to new highs or within 10% of their 52-week high prices, all based on the belief that the Federal Reserve (the Fed) will cut interest rates this September 2024. The problem is that most participants front-ran this new trend to essentially ‘price in’ these interest rate cuts into the market’s valuation.

Often referred to as a ‘buy the rumor and sell the news' event, some investors are now on edge. The Fed’s decision could trigger a disappointed sell-off or an inventory adjustment sell-off. Some indicators will show investors why this might be the case. Still, price action across different asset classes should be considered before they dig into those. Here's a look inside the technology sector through NVIDIA Co. (NASDAQ: NVDA), the bond market through the iShares 20+ Year Bond ETF (NASDAQ: TLT), and even commodities like oil and gold.

Current Price Trends: What to Expect Moving Forward

Based on the current price of the S&P 500, the overall expectation is that the Fed will cut interest rates this week, as Fed Chairman Jerome Powell promised when he spoke at Jackson Hole. However, markets have no way of knowing whether the Fed will cut by 25 basis points (bps) or by 50bps.

This uncertainty could create some volatility in the coming days, though the CME's FedWatch tool has now calculated the odds between the Fed's two choices. There is now a 61% chance of a 50bps rate cut and a 39% chance of a 25bps cut.

The implications are bearish both ways; here's why. Suppose the market is correct and does get a 50bps cut. In that case, the Fed is basically admitting that the economy is in dire need of help, something that the rising unemployment rate and contracting manufacturing PMI index would confirm.

On the other hand, getting a 25bps cut could create a disappointing sell-off as the market did not get the expected outcome. Because both scenarios could lead to lower stock prices, some markets have behaved as if preparing for this potential turn.

Gold and Oil Price Action Signals a Warning Ahead of Upcoming Rate Cut Decision

Gold reaching a new all-time high sends a cautionary signal to both the stock market and the dollar. As a traditional safe haven, the strong demand for gold suggests that investors may not be confident about the future of the markets. The same could be said about the dollar, a vote of no confidence in the currency's future.

On the other hand, the price of oil, which has struggled to stay above $70 a barrel, signals a potential recession in the future as business activity and demand may be in prolonged contraction. Warren Buffett knows that the bottom could be nearing for oil, as he bought 29% of Occidental Petroleum Co. (NYSE: OXY) in view of the worst being priced in now.

The same could be said about the SPDR Gold Shares (NYSEARCA: GLD) as it hits a new 52-week high. More than that, individual precious metal mining stocks like Hecla Mining (NYSE: HL) have Wall Street analysts forecasting up to 125% earnings per share (EPS) growth in the next 12 months.

Hecla Mining stock now trades at a new 52-week high, while Occidental Petroleum stock trades at a much lower 72% of its 52-week high. This price action shows both the expectation of a bear market in the coming months as well as a further flight to safety.

Bonds Now Hold Preference Over Technology Stocks in the Current Market

After NVIDIA stock released its latest quarterly earnings results, the stock sold off from its high to 83% of its 52-week high. The reason for the sell-off is mainly attributed to concerns about oversupply in the coming quarters, where demand might not catch up.

On the other hand, the iShares Bond ETF is now trading at a new 52-week high instead. Because bond prices move opposite to their yields, traders are ditching the high-flying stocks in the market to go into bonds, expecting that investors will sell the news of interest rate cuts, making safer assets like bonds more attractive.

The money shifts between these asset classes and specific stocks now create a narrative that could turn into wider sentiment to sell the news for the Fed’s announcement, realizing that most of the rumor is now priced into stock prices and then some.

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