During the Iraq War, President George W. Bush’s Defense Secretary, Donald Rumsfeld, was asked about the lack of evidence linking Baghdad to Al Qaeda.
His response was one for the ages…
“There are known knowns: There are things we know that we know.
There are known unknowns: That is to say, there are things that we know we don’t know.
But there are also unknown unknowns: There are things we don’t know we don’t know.”
Every investor must approach the market with the same mentality.
The biggest market risk is always total uncertainty.
There are things we know we know, such as last month’s Consumer Price Index, which came in at 7%, or that Netflix’s subscriber growth is slowing.
There are also things we know we don’t know.
We know the Federal Reserve is meeting this week. But we’re uncertain of the outcome.
We know Apple is reporting earnings on January 27. But we’re unsure of what those numbers are.
In the stock market, it’s the unknowns — the things we don’t know we don’t know — that cause financial panics.
The most recent example of this is the March 2020 coronavirus crash.
Who would have imagined that a bat virus that started in a Chinese wet market would shut down the global economy and crash the MSCI World Index by 34% in 33 days?
The other “unknown unknown” in my investing lifetime was the 2008 financial crisis.
Today’s stock market faces another big unknown — uncertainty of where interest rates will be at the end of the year.
It’s why stocks and cryptos have gotten off to one of the worst starts to a year in history.
As I’m writing this, the S&P 500 Index is down around 10% in January.
But this unknown is a less dangerous “known unknown.” It’s not another financial crisis or global pandemic.
And that’s why I believe the markets are likely to bottom soon and move higher.
The Biggest Unknown of the Day
It’s no secret that the Fed will be raising rates this year.
It has strongly suggested rate hikes are coming in Federal Open Market Committee (FOMC) minutes and public comments.
And its so-called dot plot shows officials expect to raise the fed funds rate three times this year and three times in 2023, based on median projections.
Moreover, we can see what the market thinks the Fed will do this year based on the CME’s fed fund futures.
(Source: CME Group.)
This graph shows the probabilities of where fed funds will be on December 14, 2022. That’s the last FOMC meeting of the year.
Currently, there’s a 31.7% chance that the Fed will raise rates four times this year.
There’s also a 26.7% chance that the Fed hikes rates three times and a 20.2% chance the Fed hikes rates five times.
The biggest change in the last month is that the market was pricing in a 23.6% chance of two rate hikes, and now that’s down to an 11.5% chance.
What’s important here is the change in those probabilities.
Institutional investors are preparing for a faster pace of rate hikes than they were only a month ago.
When they do that, it becomes less of a known unknown and starts to become a known known.
We also know that the Fed doesn’t like surprises.
Almost every move that Chairs Jerome Powell, Janet Yellen and Ben Bernanke have executed since the financial crisis has been perfectly telegraphed.
And once this risk becomes a “known known,” it takes the uncertainty out of the market. That should lead to higher prices.
Editor, Strategic Fortunes
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