Snapshot Notes - December 11, 2007

As of:

SPX 1513

This morning, we discussed a couple of possible scenarios surrounding the FOMC announcement. While I find it tedious and more than useless to listen to economists drone on about what the Fed might do, I do find value in observing the smartest prognosticator - the Fed Funds futures market.

Those contracts were split between a 25bps cut and a 50bps one, with the former weighted about twice as likely as the latter. My guess was that if the Fed went along with the futures market (again), then we'd likely see a sell-off in equities.

That's all a guess, and more of a gamble than anything, so instead of risking capital on a hunch, I'd rather wait and see how extreme of a reaction we'd get. Typically, a big move either way after the Fed decision provides us with an opportunity to trade the other way within the next day or two.

And today's post-Fed reaction could certainly be considered extreme. In fact, it's the 2nd-largest decline in the past 36 years on a day when the Fed cut their target rate (the largest being right after 9/11). While that doesn't sound like a particularly good reason to be optimistic, I went over some data earlier this afternoon which suggested that it may actually be quite a good reason to be positive, at least in the short-term.

In the majority of cases after bad reactions to an FOMC decision (whether they cut rates or not), the S&P 500 had a moderate tendency to see a minor amount of further downside pressure, but then an even stronger tendency to rebound over the next several sessions.

The broad guideline that seemed to apply to most cases was if we got another 1% to 2% of downside (from the close on the day of the meeting), then that most often proved to be a good spot to look for a long entry and hold for a few days. I'm not sure if we'll see that much more pressure in this case, but like I noted earlier today, it's just good to know that it wasn't usually a good idea to be an aggressive buyer right away after a pounding like we were getting.

Given all the indicators and studies we discussed in mid-November that suggested a one- to three-month rally of 5% - 10%, the overall neutral-to-positive trend in the major indices, and of course the consistently positive end-of-year / beginning-of-year seasonality we're heading into, not to mention the reversal stats we went over earlier, I don't think today's butt-ugly performance is cause for overdue concern. While I'm not champing at the bit to be an aggressive buyer, I will become more interested if we see a big gap down opening tomorrow, or some early-morning selling pressure.

As of:

SPX 1513

HELP ARCHIVE

Well, now that the big unknown is out of the way, we can get back to work again.

The Fed Funds futures market nailed it again, with the FOMC lowering its target rate by 25bps. In my take-it-for-what-it's-worth note this morning, my guess was that if they happened to go along with the futures market again, that we would most likely see a sell-off in equities, a quick rebound, then more selling pressure. Trying to game the quick post-release news is not my bag, but if we saw an extreme move one way or the other into the close, then it may provide a "fade" opportunity.

Here's the kind of thing I'm talking about...there have been 14 occasions since 1996 when the S&P 500 closed below the low of the past two days on the day of an FOMC announcement. Three days later, the S&P was positive 10 times by an average of +0.2% and five days later 11 times by an average of +1.1%.

If the S&P lost more than 1.0% on one of these days, then the rebound tended to be stronger. The S&P was positive three days later five out of seven times by an average of +0.5% and five days later six times by an average of +1.8%. The sole loss was immediately after 9/11.

The assumption this afternoon is surely going to be that if the market falls so much on a day the Fed cut rates, then that has to be a bad sign going forward. I see the logic there, but logic usually doesn't have much place in the stock market.

Going back to 1971, I checked for any time that the S&P dropped 1% or more on a day the Fed cut. There were only five instances that popped up, and the S&P formed at least a short-term low within two days four of those times. The best bet was had by waiting for an additional 1% - 2% of downside, then buying and holding for a few days or 2% - 5% upside. Again, the only real exception was immediately after 9/11 when we sold off for a few more days (and about -9%!) before stabilizing.

So these precedents don't paint a particularly bleak picture. Given all the intermediate-term positives we'd gone over, the fact that we're already seeing some minor oversold readings, and the potential for buying support around this 1480 - 1500 zone in the S&P, I don't think today's move is all that ominous.

There does seem to be a tendency for stocks to exhibit more very short-term weakness after weak reactions like this, and trying to buy right away wasn't often the best decision. I'm going to keep holding off here and see how we close - if we get a weak close and a gap down open tomorrow, then that's the kind of situation where I'd be more inclined to be a buyer.

As of:

SPX 1513

HELP ARCHIVE

Good Tuesday morning...We begin the day with mixed trading in the major indices and most of the broader sectors as traders await some clarity from the Federal Reserve early this afternoon. We have less of a consensus than any other time I remember this year as to what the Fed will do, so I anticipate some higher-than-average volatility going into the close.

We left off yesterday with a market that defied some minor short-term negatives and continued the oversold rally, by breaking out over Friday's highs and holding there throughout the day. Other than some breadth divergences that are beginning to pop up, I'm finding little that suggests the market is doing anything "wrong".

Given the big slug of historical "excessive pessimism" readings we went over in mid-November, this positive behavior suggests that we should see still-higher prices in the intermediate-term of one to three months.

The short-term is much more up for grabs, and is held captive by this afternoon's reaction to the FOMC decision. On these days, we often see a moderately positive drift into the afternoon, then two or three wild swings, before a more trending move into the close.

Instead of wasting any time on the futile exercise of trying to predict what the Fed should or will do with regard to its rate target, I prefer to just look to the Fed Funds futures market and see what the consensus is. That market is more accurate at predicting changes than any economist I have seen.

Currently the market is split between a 25bps cut and a 50bps one, with a heavier tilting towards 25bps. My for-what-it's-worth-which-isn't-much guess is that a 50bps cut will see the stock futures soar higher immediately, then drop back, then continue higher again into the close. A more-likely 25bps cut would likely spur the opposite reaction. A wild card is the Fed statement, which could be more aggressively worded than before, and/or an additional Discount Rate cut.

Whatever happens, I'm not going to try to game the impossible-to-know initial reaction. The better trade surrounding these events is to fade, or trade against, an extreme reaction in either direction. Very often, we see the markets retrace an extreme move after the Fed decision, so that's something we'll go over more in-depth towards the close. In the meantime, I'll sit in cash for trading accounts.

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