Snapshot Notes - June 23, 2008


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MONDAY, JUNE 23, 2008

Traders Turn Toward Fed

06/23/08 9:10 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Monday morning...We begin the day with a modest bump up in the pre-market futures, after a volatile overnight session. The weekend news flow was relatively slow, which was a relief to many after the concerns from Friday.

Unfortunately, for the next two days we're going to be bombarded by opinions on what the FOMC will (or should) do at this week's rate meeting. Opinions are flying fast and furious due to Chairman Bernanke's latest comments, but as always I find it a waste of time to engage in that guessing game.

Rather, I prefer to just watch the futures markets, as they have very rarely gotten it wrong when we're within a couple of days of the meeting. The chart below shows the expectations of a cut in rates, raise in rates or no change over the past couple of months via the pricing of Fed Funds futures contracts.

We can see that there was about a 50/50 chance of either a drop in rates or no change as late as early April. As inflation concerns kicked in, however, the probability of a rate reduction dropped and is now given a 0% chance. Over the past week, as equity markets tumbled and financial concerns grew again, the odds of a rate raise have declined, from about 40% on June 10th down to 10% currently.

So, my guess is the Fed does nothing on Wednesday, unless these odds change dramatically in the next couple of days. The only real economic report that could influence the odds is the Durable Goods report on Wednesday morning, but I don't suspect we're going to see these change much.

The market hasn't had a real consistent flow prior to scheduled FOMC meetings, though there has been perhaps a slight negative bias over the past year in the couple of days leading up to them, then a modest upward drift the morning of the meetings. Sometimes we saw the market scrunch into a tight little range in the days preceding the meeting, others we saw it swing wildly in both directions. These are very difficult announcements to game, with little consistent edge either way, and I prefer to stay away.

Over the weekend, I posted a longer-term comment that looked at some of our intermediate-term gauges. The bottom line was that we've seen an extreme in the Dumb Money Confidence that has resulted in excellent three-month gains 100% of the time it has become this low, but that's not being confirmed by many of the other guides.

On another potentially positive note, we have seen the pace of short-selling from the public pick up. According to the latest data from the NYSE, "the public" accounted for 73% of all short sales, while "smart money" specialists and other members made up a mere 4% and 23%, respectively. There are just two problems with this: 1) the data is two weeks old and 2) the public, according to the NYSE, includes hedge funds and other sophisticated investors.

This data has still had a relatively good record at highlighting times of risk and opportunity, even given some major distortions over the past couple of years. When we look at the Public Short Ratio either with some kind of relative trading bands or on a de-trended basis, when it has become extreme it has done a pretty good job for a contrary indicator. The last few big spikes in public short sales (March, August and November 2007) were all pretty good buying opportunities, so the latest dramatic move could be seen as market positive.

I hesitate to assign a lot of weight to this indicator because of the reporting lag of two weeks, and also due to the increasing popularity of 130/30 funds that are essentially forced to sell short some stock, whether they're bearish on the market or not. These funds are also one reason why I wrote about short interest losing some of its effectiveness back in January.

On a short-term basis, we're seeing a gap up this morning, after a pretty tough week last week. Historically when the S&P 500 tracking fund, SPY, has lost 1.5% or more on a Friday then gapped up 0.5% or more Monday morning, buying the open and selling at the close resulted in gains 68% of the time (15 out of 22) for an average of +0.4%. The losing trades were mostly minimal, with only one loss greater than -1%. But holding over the next couple of days actually showed a negative expectancy.

This is a tough juncture for traders. We have some signs of excessive pessimism, best reflected in the Dumb Money Confidence. Given that and Friday's big drop, I would typically be looking to be a buyer. But our short-term guides are mostly neutral despite the declines to end last week, and I detest chasing a gap up opening in the context of a bear market, under resistance levels, with a major unknown looming (the FOMC decision). My plan at the moment is to stay in cash and wait out this gap - if we can get a better short-term oversold condition, then it may be worth a shot on the long side given the intermediate-term notes we've discussed, but other than that I don't see much of interest.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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