Snapshot Notes - October 31, 2007

As of:

SPX 1511

Today's trading has played out pretty well in line with past FOMC announcement days, with the major indices displaying an upside drift heading into the early afternoon, and we've had a couple of violent whipsaws afterwards.

The reaction in stocks has been quite positive, with the S&P 500 up nearly 1% earlier, before drifting back a bit in the past half-hour. Long-term notes and bonds, on the other hand, haven't taken it so well, with the yield on 10-year Treasury Notes climbing by over 2% on the day.

I can find five other occurrences of the markets behaving this way on a Fed meeting day (meaning the S&P 500 up 0.5% or more, and 10-year Note Yields also up 1% or more). The following day, the S&P fell back all five times, by an average of -0.8%. A week later, it was still negative four of the five times (the one positive was *just barely* in the green), though the average return was only modestly negative at -0.9%. Mostly, we just saw a lot of chop over the next week, with a downside bias.

But the Fed did cut their target rate, and as I noted this morning, equities have tended to respond well to these second cuts in the cycle. So which is going to be more important...the fact that the Fed cut, or the fact that stocks have seemingly over-reacted?

I tend to side with the latter, at least in the short-term. We consistently see a give-back after extreme moves based on economic events such as these. Combined with overbought conditions like we currently have, it would be unusual to see a sustained jump from this news. I suspect we're more likely to see choppy downside, at least for the next several sessions. I'm not trading that way at the moment, however, as I want to give these gyrations some time to play out.

As of:

SPX 1511

HELP ARCHIVE

Good Wednesday morning...we begin the day with large gap up openings in the major indices as the futures have rallied steadily from yesterday's close, and were helped along by this morning's surprising GDP report.

I'm not going to engage in any inane chatter about what the FOMC might or might not do today - I have no edge in the matter, and it's nothing more than a waste of time. I prefer to just look at the Fed Funds futures market and see what they're forecasting. They have a good enough record that it beats the pants off almost any Ivy-league economist.

Currently the futures market is suggesting that the Fed will cut rates by another 25bps today, so let's go with that. Assuming they do, it will be the second cut in this cycle. Looking back over the past 30 years, the market has had a pretty good reaction to this additional cut, showing positive returns a week out 5 of 7 times by an average of +1.5%.

One of the interesting aspect of this particular meeting is that we've seen technology shares run up so much leading up to the meeting. So perhaps we're due for a little "sell the news" reaction in these shares? To see if history can provide any guidance here, I looked for any time when the Nasdaq 100 rallied by more than 4% in the month leading up to a rate cut.

In the past 20 years, it has happened 9 times. Somewhat surprisingly, the NDX closed the day in positive territory 7 of those times by an average of +0.5%. On average, the index was able to tack on +1.8% during the day, while losing -1.0% sometime during the day as well, though that was mostly due to one whopper of a decline (-3.5%) in January 2001. Without that one occurrence, the intraday drawdown dropped to -0.7% on average among the other instances.

Even by a week later, the NDX was still positive 6 of the 9 times by an average of +2.3%. When looking out a month later, we see substantially similar results, so it's hard to make the assumption that we'll sell off on today's news just based on the fact that the NDX has rallied smartly over the past month.

This would be the first time that I can find where the NDX was up more than 4% over the past month going into a rate cut while the S&P 500 was down more than 1%. In fact, I can't find any other time when the S&P hadn't rallied at least 1% over the past month, so this kind of wide divergence among the indices is something new.

This would also be one of the rare times that the S&P is gapping up so much on a day the Fed cut rates, before we even know that they're going to (assuming they are). I can find three other times that the S&P 500 futures opened up more than +0.5% on a day the Fed cut, and it actually managed to close higher than the open all three times by an average of +1.3% (though almost all of that was due to one instance in April 2001).

I mentioned yesterday that I wasn't doing anything for trading accounts ahead of the FOMC decision, and that's still the case. We have a mixed picture currently in terms of technicals/sentiment versus seasonality on both a short-term and intermediate-term time frame, so I expect continued choppy conditions in both time frames.

I noted yesterday that we typically get a mild upside move leading into the early afternoon of these rate decision days, then two or three violent whipsaws afterwards that can erase the moves seen during the prior several days, so I'll be watching for something similar today. If we get an extreme reaction one way or the other going into the close, then we might have an opportunity to fade that in the coming days, based on the "Fed reversal" pattern that occurs so frequently.

Forwarding or otherwise distributing this copyrighted material is a breach of your subscriber agreement. Violators are subject to termination of their subscription with any received subscription fees forfeited. Any references to historical performance are based on data we deem to be reliable, but are based upon feeds from third parties. We do not recommend subscribers take positions based on data presented here alone, but rather incorporate it into a comprehensive investment outlook.