Snapshot Notes - October 25, 2006

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WEDNESDAY, OCTOBER 25, 2006

PostCloseSummary

10/25/06 5:00 PM EST

The last time the S&P 500 rose more than .35% on a day the Fed released its target rate was just last month. In mid-September, the S&P was hitting a new high, traders responded well to the Fed's message and all looked well.

Two days later, though, the S&P was nearly 1% lower and traders were wondering if it was so wise to buy after all. That's historically been the tricky nature of these kinds of news events - the initial relief or doubt after the news hits is most often reversed in the days following.

There have been 10 times in the past three years when the S&P closed up as much as it did today on a day the Fed announced a rate decision. Three days later, it showed a positive return after only two of those occurrences (and both were minimal gains) - it has just not paid to chase post-Fed moves in the short-term. That's also the case if bond traders were happy too - when both stocks and bonds rose, then the reversal tendency was still in effect.

I'm seeing quite a few volatility contractions out there - we're getting one in our STEM.MR model as traders have been becoming less bullish on rallies and less bearish on declines, and we're seeing it in the Nasdaq 100 as that index winds up into an ascending triangle.

This pattern should bust soon, and if it's to the upside, then perhaps we'll finally get the climax of buying pressure as the last standouts rush to join the year-end party. If the NDX and Russell 2000 can finally overtake and hold last week's highs, then I will be trading from the long side as long as those highs hold. Given the negatives I've gone over in various comments over the past couple of weeks, I'm also interested in pressing the short side should the NDX instead fall below 1700 again. We should get a resolution one way or the other very soon, and I'm ready to follow along.

Have a great night and we'll see you tomorrow!

ApproachingTheBell

10/25/06 3:25 PM EST

Every time one of these Fed rate decisions rolls around, we get pretty consistent trading activity - a tight range (perhaps slightly upward-sloping) with low volume in the hours before the announcement, then two or three sharp swings in every which direction afterwards followed by a more directional drift into the close.

Today has followed the precedents closely, and now we'll see if there's any kind of a trending move one way or the other into the close. I've noted repeatedly the tendency for post-decision moves to get reversed in the days following, particularly if the move is large.

Just as one more look at it, there have been 7 times since 1999 that the S&P closed positively on a decision day, and the yield on 10-year T-Notes declined by 1% or more (i.e. the knee-jerk reaction from stock and bond traders was to buy). Three trading days later, the S&P showed a positive return only twice, and its average return was -1.0%. The better the S&P does heading into the close, the more I think the move will be retraced over the next few days.

I've been sitting out these whiplash moves as the conditions I gave earlier that would prompt me to trade have not been met. I'm still willing to (gingerly) trade from the long side should the Russell 2000 and Nasdaq 100 trade and hold above last week's highs, and would look to be fairly aggressive with short trades if the NDX fails to hold above 1700.

LunchtimeLull

10/25/06 12:25 PM EST

Today is following the pre-Fed announcement script to a "T" as the S&P has flattened out and volume has dropped off to a fraction of its normal levels. Barring some news event, I don't suspect this will change much prior to the rate decision and statement.

I never game the post-Fed reaction, as I have no edge there. We will most likely see two or three violent whips, then a more directional move going into the close, though as mentioned yesterday even a large directional move after the announcement has been a very poor predictor of the way equities will move in the following days.

MidMorningOutlook

10/25/06 10:25 AM EST

Good Wednesday morning...The highest of the high-beta sectors, internets and semiconductors, are racing out of the gate this morning, both up over 1.5%.

When we see traders willing to bid up historically "risky" sectors, it generally tends to bode well for stocks in general. That has become kind of a cliché for market analysts, but it is one of those rare pieces of market wisdom that actually holds up under closer scrutiny.

The morning of a Fed rate decision has often had a slight upward drift to it, with volume dropping off to near nothing after about 11:00am EST. Afterwards, of course, the fireworks begin and we usually see an intraday range that is about twice what it was the day before.

I'm not expecting too much of a move either way leading up to the announcement. If the Russell 2000 and Nasdaq 100 break out and hold above last week's highs (770ish and 1730ish, respectively), then I'll be focusing on long setups. If, instead, the NDX breaks below 1700ish and holds for more than 1/2 hour or so, then I will be concentrating quite aggressively on shorts. I don't expect either situation to occur prior to the rate decision, but if so I will be flattening any positions prior to the announcement.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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