I suppose I should kick things off with a word about the Fed, but I will refrain for the moment from discussing the unprecedented action the central bank took yesterday afternoon. Instead, I want to focus first on the technical side of the environment in light of the massive over 6% move made in merely 75 minutes into Tuesday’s Close. Just as long only investors started to pull the Pop Rocks and Coke from the shelves, stocks somehow managed to enjoy the first real bid in nearly three weeks. Some of the best technicians on the Street utilize various oscillators, moving averages, sentiment indicators, trend lines, etc. to predict market direction. As an amateur, I like to rely on things such as the NYSE TICK and open interest in the futures to guide my decision making.
Alas, the support from round numbers of major macro securities, the simplest of all indicators, ultimately provided the backstop to prevent another rout in equities. More specifically, the test of 1,100 for the S&P 500, which bottomed at 1101.54, and 2.00% for the 10YR yield, which hit an all time low of 2.03%, spooked traders enough to unwind and possibly reverse positions to launch the market. Tuesday’s bottom may not end up as “the bottom,” but there is precedent for the magical powers of index milestones to alter the course in stocks. For example, during the magnificent rally from 2003-2007, there existed only three retracements greater than 7% for the S&P 500. The second of such pullbacks occurred during the first four months of 2005 which provided a fair dose of fear among investors given a backdrop of near zero volatility. On April 20, the DJIA traded down to 10,000.46 which remained the bottom tick for nearly 3 ½ years and sparked a 17% rise in the S&P 500 before encountering the third blip of the rally 13 months later.
I suspect the unwinding of the record 370K and 905K new E-Mini equivalent contracts opened on Monday and in aggregate since July 25 respectively had more to do with the rapidity of the ascent than anything else; however, there was much to like about the internals of this spectacular move. First, the session’s return improved as one traveled down the market capitalization curve of indices which suggests larger, and by extension smarter, hedge funds aggressively tried to augment their risk profile. The performance breakdown of each of the ten sectors implies the same conclusion. Next, the +1,560 TICK printed at 3:45 PM represented a 13 month top while the number of measurements that exceeded +1,000 totaled 466, easily a high water mark since I have been tracking the data.
Furthermore, not only did the net difference between these readings and those that fell below -1,000 reach a record, but the 186-6 scoreboard of such recordings from the day’s low into the Close also reflects the power of this late session ramp. In short, the rally was as close to as flawless as possible. Although the bears will rightfully reference the near perfect technical collapses over the past several days, the mere fact that the sharp snapback forced those short or overly hedged to recognize less than desirable performance will curb some of their unabated selling we have witnessed recently.
I am further encouraged by the response to the Fed’s actions yesterday afternoon as the market resolved to the upside as traders acknowledged that a negative assessment of the economy from the FOMC reflects only its members’ opinion and likely will trigger more accommodative policy in the near term. It is a rare occurrence these days when stocks and bonds trade in concert as they did briefly in the afternoon, but the implications of lower rates from parabolic treasury prices resulting from a central bank release should provide a stiff tailwind for equities. In the old days, this happened all the time with the unmatched secular bull market from 1982 until 2000 supplying the best example.
The talking heads on CNBC focused on the shocking admission from the FOMC that targeted fed funds rates will remain “exceptionally low” through mid-2013. Certainly, note holders on the front end of the treasury curve would agree that this definitive proclamation represented the crux of yesterday’s announcement. However, I tend to believe that the Committee’s significant downgrade of the economy marks the most critical piece of information one can glean from Tuesday, for it again puts the central bank on the doorstep of another round of quantitative easing such that investors should expect a launch of QE3 as early as Chairman Bernanke’s August 26 Jackson Hole speech or no later than their next scheduled meeting on September 20 assuming the recovery stumbles again.
Finally, I have always made it a point of emphasis on the timing of inflection points. I have argued that after the usual whipsaw immediately following the announcement, equities typically discover their last move of a Fed day sometime between 2:35-2:45 PM as that is when traders typically click on their programs to avoid the negative selection that can arise with such a material piece of news. With yesterday’s lows arriving in the heart of that aforementioned sweet spot, I am hopeful that any erosion of volatility will entice even bigger money to place stocks on a clear path higher.
S&P 500 SEP E-Minis Key Technical Levels
Support: 1157.00, 1133.00/31.00, 1100.00/1099.25, 1090.00, 1080.50/77.00
Resistance: 1175.50, 1178.25/78.75, 1200.00, 1212.75/15.50, 1219.00/19.50, 1228.50, 1241.00