Fed Watch: Powell’s Persistent Pain Point

The last time Jay Powell crushed a promising rally, he revealed a distinct “tell” hinting at exactly how far he’s willing to let the bulls run while the war on inflation drags on. That signal flared again this week.

Once again, it’s clear that Powell will tolerate Wall Street exuberance only to the point where it could break out into a self-sustaining rally. That’s his limit. He wants to keep us on the defensive, more worried about the floor blowing out beneath us than about cracking what’s become a fairly hard ceiling.

He wants the market’s overall bias pointed downward until he declares victory on inflation once and for all. Wall Street is now a very important tool for him and his Fed counterparts, sucking trillions of dollars of paper wealth out of the economy every time stocks lurch to a new post-pandemic low.

I’m not blaming the Fed. They’re making it more difficult to grind profit out of the market week to week and month to month, but we’re still finding ways to trade around them.

The most important thing is avoiding the obvious bull traps. When you’re trading a sideways market, it isn’t enough to simply buy the dip and wait for stocks to rebound.

You need to have a sense of how far that rebound goes before you need to sell out and take your hard-won profit off the table. Calling a ceiling in this market is critical. And I can see how high Powell wants that ceiling to be.

It’s really simple. The Dow got above the 200-day moving average for a handful of days in August before Powell slapped it down from Jackson Hole. After that, it struggled for months to recover that key trend line . . . before clearing it again last week.

And then Powell decided the bulls needed a fresh lesson. Here we are.

He didn’t even let the S&P 500 get within sight of the 200-day limit this time around. Weighed down by Mega Tech names, the broad index managed to reclaim shorter-term 50-day support before the letdown.

This tells me that Powell isn’t watching Mega Tech. As far as he’s concerned, Apple (AAPL), Microsoft (MSFT) and the rest of Silicon Valley are important companies . . . but they aren’t the real center of gravity for the economy the Fed cares about.

Silicon Valley can rise or fall on its own innovation. The Fed wants to make sure that more prosaic stocks in mature industries don’t swell up with bubble money. Food, pharma, housing, retail and raw materials need to remain tethered to fundamental valuation limits.

That’s why I think Powell is watching the Dow. As long as the Dow stays in his comfort zone, he’ll trust that those essential industries are free of irrational exuberance. When they edge above the ceiling, he’ll talk them down again.

In real terms, I think this means the Dow is stuck below 32,500 for the remainder of the year. And since the trend slopes softly lower, the real ceiling might end up closer to 31,000 before the Fed finally breaks the back of inflation.

That’s not a steep drop from here. It’s practically just 1% below yesterday’s bottom . . . and it really only rewinds a week or two of rally. We managed to survive with stocks below that level for most of September and October. It hurt, but it didn’t kill us.

The question is where the new floor ends up because that tells us how much pain we’ll need to swallow in the next few months. For the Dow, any move below 31,000 opens us up to a potential 1-2% break below the October low.

At that point, we’re already trading lower than the pre-COVID peak, which winds back three years of turmoil and progress. I’m not saying stocks stay at that depressed level forever . . . but it takes time for sentiment to recover.

The NASDAQ is the biggest threat here. The giants that dominate it have become a net drag, leaving it vulnerable to a drop back to 2019 levels before any support emerges. Stay in the real economy until Big Tech finds a real bottom.

And if this week left bruises, remember the Powell factor the next time the Dow approaches that 200-day line. Coincidence or intent: either way, he isn’t going to let it rally beyond that pain point for the time being.