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Market Wrap

FOMC Two-Step

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I (Keene Little) will be filling in for Jim tonight. The market did the two-step dance after the FOMC announcement this afternoon. After showing disappointment in the FOMC's decision, with the DOW dropping about 150 points, "someone" came in and goosed the market with a few buy orders and spooked the shorts. The DOW then rallied 250 points in about an hour. But there wasn't enough buying to keep it going and it settled back down 100 points into the close. And where did it end? Right where it was before the FOMC announcement. Me thinks there's a tad bit of volatility in this market.

The volume numbers in the chart above are highly suspect. I tried several sites and my QCharts and came up with different numbers. For some reason the volume numbers have been highly suspect for the past few weeks. But QCharts is reporting total volume at 5.2B shares and that seems about right (and average). Volume spiked up big during the hard selloff and that is of course not what bulls want to see. If it were just a correction to the rally then preferably we'd see the pullback on lighter volume. Instead it appears as though the bounce is now on lighter volume than the selling that preceded it.

In a "normal" pattern it looks like the bounce we've had over the past week is fairly typical. It's when you look at the moves that you realize the magnitude of the them in the number of points this market is moving. Traders who can catch each of the moves have been doing very well. But I suspect many traders are getting their heads handed to them as they get whipped around. This afternoon's volatile down-up-down sequence chopped up many market participants.

And it's not just the little trader who's having a tough time. If you missed Jim Cramer's meltdown on CNBC last Friday, you can find it on YouTube, and it's a must-watch. He basically said Bernanke is an idiot for not recognizing how bad it is out there and that all his billionaire friends in the hedge fund industry are losing their funds and jobs. All together now--awwwww, cry me a tear Jimbo. These people are the ones who don't have a clue what the real world is like. I'm gaining more respect for Bernanke the more I read about him (unlike Greenspan who will go down in history as the man who created all these bubbles and the resulting consequences).

Bernanke has been letting the market know that he is not interested in following Greenspan's legacy of jumping every time the market hiccups. The "Greenspan put" got its name because of Greenspan's reputation to proactively get involved in the market to hold it up whenever the financial market got into trouble. Saving his well-healed friends on Wall Street became more important to him than serving the public. Do you think it's a coincidence that he's a consultant to the bond market gurus now?

Initially everyone thought Bernanke was going to follow right behind Greenspan and protect the markets the same way. His statement about the wonderful invention they have, called the printing press, to prevent deflationary problems earned him the nickname Helicopter Ben--he was prepared to dump massive quantities of money onto the market from his helicopter. This then led to a continuation by market participants to take extraordinary risks for extraordinarily low premiums. The general consensus was that the Fed would protect them. This sounds like the interview I read about a trader in China that said "the government will not allow the stock market to crash and therefore I have no risk". Guess what's next?

Recently, with the market turmoil, Bernanke has been essentially telling the market that there is no longer a Greenspan put. He has said he will allow the market to sink or swim on its own and he will allow it to find its own bottom without the Fed's interference. I strongly suspect he'll be forced to get involved, out of fear as much as anything else, but then it will likely be too little too late.

Hence Cramer's outrage at Bernanke for his unwillingness to bail out his billionaire friends who are being forced to sell their 142-foot yachts and homes in Aspen, CO. Between Cramer's admission to the lying, cheating and stealing he was doing as a hedge fund manager and now his crying about his friends losing their jobs for essentially stealing candy from little children, all I can say is that it's about damn time. I think there are a few of us who have been totally dismayed by the greed of these people who make hundreds of millions a year (or more) and it's still not enough. Oh boo hoo that they're losing their yachts.

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Bernanke is proving he doesn't run with the hedge fund crowd and for that I'm cheering. He's an academic and out of touch with the real world and for that reason I worry but at least he appears not to be beholden to the wealthy on Wall Street. We can therefore hope he will be a better public servant than his predecessor. Giving him the benefit of the doubt I suspect he will make the right decisions but make them too late. The market and economy will tank on his watch and he'll get the blame but I truly hope that the right analysis is done to show that it was Greenspan who put us in this position and that Bernanke was just the poor guy without a chair when the music stopped.

And that takes us to today's FOMC announcement. But before covering that, I'll review today's other economic reports.

Economic reports
Today's reports included preliminary Productivity report in the morning, the FOMC announcement this afternoon and the Consumer Credit report at 3:00 PM.

Productivity-Preliminary
Productivity of the non-farm business sector rose at a +1.8% annual rate in the 2nd quarter which was lower than the expected +2.1%. Unit labor costs, a key inflation component for the Fed, rose at a +2.1% annual rate, higher than the expected +1.6% rate. Lower productivity with higher labor costs is a recipe for inflation as businesses will be forced to raise prices to cover costs, or they will have to absorb the added costs which will obviously lower their earnings.

On top of this bad news for the Fed (and market), the 1st quarter productivity number was revised lower to a +0.7% rate from the previously reported +1.0%. And 1st quarter labor costs were revised higher to +3.0% instead of the +1.8% rate that was previously reported. Compared to the same quarter a year ago, productivity was up only +0.6% while unit labor costs rose +4.5%, the fastest pace since the 3rd quarter of 2000.

This was a very negative report for the market and it initially dropped on the news. But the market seemed to have an agenda today and that was to get the market as high as possible before the FOMC announcement.

FOMC announcement
"Although the downside risks to growth have increased somewhat, the FOMC's predominant policy concern remains the risk that inflation will fail to moderate as expected." They kept rates steady at 5.25% for the ninth straight meeting. That was all the market needed to hear and the initial reaction was a hissy fit with strong selling. Where the initial buy programs came from can't be known but it was enough to spark strong short covering and the market got jammed higher before settling back down into the close.

The Fed essentially said they're maintaining their focus on inflation instead of a slowing in the economy. They acknowledged the volatile financial markets, tighter credit conditions and the continuing correction in the housing market but felt their chief concern had to be the inflation risk. The feeling by many is that the Fed feels no responsibility to bail out hedge funds who speculate on high-risk investments. Jim Cramer is probably throwing his own little hissy fit this evening, calling Bernanke a man who is out of touch with reality who doesn't recognize how much trouble his billionaire hedge fund buddies are in. I'd enjoy watching his next tirade but personally can't stomach him.

With the core inflation rate running at a +1.9% rate, just within their 1%-2% comfort zone, one would think the Fed could start to relax a little. The problem is the next six months which when compared to the last six months of last year, will very likely tick higher than 2%. And I think the Fed is fully aware of this and rather than change their language now, only to have to change it back again at the next meeting, they're simply staying the course and sticking with their message.

Bernanke appears to be more interested in a longer term view of the economy and markets. He's willing to let them fluctuate as long as he believes the overall trend is in the right direction. If he succeeds in doing this (probably won't but it's better than creating a yo-yo market like Greenspan did) then I think could create a much more stable economy. I've got my fingers crossed for him.

Consumer Credit
Outstanding consumer debt piled up at +6.5%, or +$13.2B, for a total of $2.46T in June. This is the 2nd consecutive month that overall consumer debt rose primarily due to an increase in credit-card debt. Adding in other revolving debt caused consumer debt to rise at a +8.4% rate. May's gain was revised upward to +12.2%.

One can only speculate as to what's being put on those consumer credit cards. Without the ability to tap into the home equity accounts it would appear that the consumer has been unwilling to slow down their spending and is simply adding it to their credit cards. Some banks started a program where the homeowners could pay their mortgages with their credit cards (I won't even mention how abundantly stupid that is). The bottom line is that consumers are digging themselves a deeper hole, and they need to stop digging.

The net result of all the bouncing around that price did today was a positive day for the indices. My sense is that we'll see a pullback tomorrow but it could be a choppy day. So onto the charts:

DOW chart, Daily

The bounce in the DOW is currently looking corrective and that's the way I have labeled for the bearish (dark red) wave count. It found resistance at its 50-dma today and it's possible the bounce is finished so be careful if you bought this dip. There's a Fib projection up near 13750 as far as upside potential and of course the bulls could simply drive this higher just like they did off the March low and at least get it up for retest of the broken uptrend line from March (for a new high around 14200). A rally above 13822, a 78.6% retracement would be a break back above its broken uptrend line and be indicative of a new high coming. Until that happens I'm looking to short this rally. But it might be a week early to do that:

DOW chart, 60-min

This afternoon's spike up and down made the intraday pattern a little strange but there's a way to consider the corrective bounce from last Wednesday's low as finished and now we'll start a new leg down (light red wave count). There are several possibilities here, as corrections can do any number of things and is one reason they're so hard to trade, and I only show 3 different ones. We could see price press higher to the upside Fib projection at 13751 and then head south in a hurry (wave-3 down) or it could pull back first to around 13320 before heading back up, either to a new high or just a higher high in its bounce (see SPX chart for that depiction). It takes a break below 13135 to confirm that the bounce is finished and short is the place to be. So 13822 for the bulls and 13135 for the bears--that's a wide spread and in between it could be whipsaw city.

SPX chart, Daily

Before the market broke down I had had SPX 1506, the low on July 11th, as a key level--break that and the market would likely see some strong selling. Now for the expected bounce (if it's to be just a correction to the decline) the same 1506 level could be critical. A 62% retracement of the decline is just under 1507. The bulls need to drive the SPX higher than 1528 which is the 78.6% retracement, the level I consider the "line in the sand". Any retracement greater than that most often leads to a complete retracement (so another new high in this case). Hence the bullish key level marker at that level. If at any time price drops back below 1427 then the bounce is finished and we'll very likely see some strong selling.

SPX chart, 60-min

Today's see-saw reaction to the FOMC announcement messed up the intraday pattern a bit and makes it a little more difficult to figure out if there's more bounce left or if we'll get a pullback first. The light red wave count says the bounce is over and down we got. The bullish (green) wave count says we're only at the beginning of the next leg higher (similar to what happened from the March low). In between is the dark red wave count (the one I'm leaning towards at the moment) that calls for a pullback, which could find support at the uptrend line from July 2006, near 1453, to be then followed by another leg up in the bounce into next week. I'm speculating on the pattern but with that kind of pullback and bounce, two equal legs up would be right on top of the 62% retracement near 1507 and the previous price level support/resistance I mentioned for the daily chart.

Nasdaq-100 (NDX) chart, Daily

The NDX daily chart is a little crowded when trying to show a few ideas of where price could go in the short term. The bulls need to drive this above 2030 and the bears need it back to a new low below 1912. The current bounce stopped at the mid line of the parallel up-channel for price action from the July 2006 low and January 2007 high which coincides with the broken uptrend line from March. This will be bearish if it can't at least get back above today's high since it will look like a kiss goodbye.

Nasdaq-100 (NDX) chart, 60-min

The broken uptrend line from March was given just a little peck on the cheek today and promptly slapped for it. The last 60-min candle looks like a bearish shooting star or dragonfly doji at resistance. It met its minimum upside Fib projection at 1969.46 for two equal legs up for its bounce off last Wednesday's low. So an immediate drop from here is possible although I don't think the pattern is suggesting that will happen. But be careful with this one.

Reviewing the Nasdaq chart shows the index to be a little weaker than the NDX:

Nasdaq (COMPX) chart, Daily

After popping above the top of its ascending wedge pattern for price action from July 2006 and then dropping back into the pattern, that created the sell signal. Breaking the bottom of its wedge was another sell signal but now we have price back inside the pattern. This is not a reliable buy signal but it does tell shorts to be cautious. The bounce off its 200-dma was about as perfect a touch as you could get. So far it has made it up to just shy of its 38% retracement of the decline. A 50% retracement would be a retest of its 50-dma and would be a good spot to test the short side.

One of the reasons I think you'll want to be looking for a short play is based on what I see in the pattern of the relative strength of the COMP vs. the SPX:

Relative Strength of COMP vs. SPX, Weekly, 2000-2007

I've shown this chart before and suggested we'd see the RS move up to the top of the wedge, indicating the techs would outperform the blue chip SPX for a little bit. I didn't know whether that would mean the techs would be leading the charge higher or if it instead would result from SPX leading the charge lower. It turned out to be the former as the techs led the market higher since May. Now notice the turn back down from the upper trend line. From an EW (Elliott Wave) perspective, this triangle pattern can now be called complete. As a continuation pattern the next move should be a break below the bottom of the pattern and a continued drop from there.

Moving in a little closer shows the move since 2004:

Relative Strength of COMP vs. SPX, Weekly, 2004-2007

The significance of this, I believe, is that the techs led to the downside last week. The weekly oscillators have turned down (turning on MACD) right after the RS tagged the top of the pattern. What this is telling us is that the techs are weakening relative to the SPX and that's very likely telling us that the bull market is dead. This is obviously an early call but based on this chart and other evidence in the move down in the indices after satisfactorily completing a long term wave count to the upside, it looks to me like we should be looking for rallies to short rather dips to buy.

Russell-2000 (RUT) chart, Daily

The small caps have one of the more bearish looking charts. Even the long term uptrend line from 2003 was broken on this decline. I show a bounce back up to around 800 for a retracement of the decline (50% and 200-dma) but that's just a guess right here. If they remain weaker relative to the others then it may not make back up that high. I'm hard pressed to put a bullish wave count on this one--I just don't see it.

BIX banking index, Daily chart

Boink! Think a few shorts covered on that bounce over the past two days? That's what you call an oversold bounce, and that's exactly what I think it is. The Fib level where it stopped is also at the bottom of its older parallel down-channel (which it fell out of back on July 24th), both of which are common resistance levels. The pattern calls for additional stair-stepping lower so I don't see anything bullish about this bounce yet. A rally back above 390 is needed to tell me the bulls mean business.

U.S. Home Construction Index chart, DJUSHB, Daily

While we could be at the beginning of a larger bounce for the home builders (light red count), I think we're seeing a small consolidation before it continues lower. The larger pattern suggests the home builders will stair-step lower so continue to short the rallies in the home builders.

Oil chart, September contract (CL07U), Daily

Oil has dropped out of its small up-channel that price was in for much of the June/July rally and found support at its 50-dma (pink moving average). The wave count calls for another high and the Fib projection at 80.67 remains a good upside target. But if it breaks below 68 then the pattern turns more bearish. A break below 64 would say we've seen the high for oil and it could be headed to new lows below 50.

Oil Index chart, Daily

The oil stocks have been ahead of the decline in the price of oil which is very typical. I'm not sure oil has finished its rally but I am more certain that the oil stocks have peaked. There are a number of resistance levels above, including the one it bumped into today--the top of the parallel up-channel from 2005 that it broke back down into on this decline. Then there's the 50-dma and then back up to around 800 if it is going to retest its broken uptrend line from March. But I'd be looking for signs of topping in its bounce, either here or within the next week, to short this index.

Transportation Index chart, TRAN, Daily

The transports broke below the uptrend line from September 2006, and its 200-dma, and is now making an attempt to get back above both. It looks like it should be able to do it and get a higher bounce to correct the decline. The 50-dma near 5181 would be a logical place to watch for resistance if it can get up there.

U.S. Dollar chart, Daily

The US dollar keeps getting bopped on the head and driven to new lows and each new low is met with continuing bullish divergence. One of these lows is going to be the last one, likely when least expected. It takes a break of the top of its descending wedge to tell us the bottom is in.

Gold chart, December contract (GC07Z), Daily

If the dollar starts a more serious rally then I think gold will be in trouble. It could rally out of this (not shown) but so far the wave pattern suggests a very fast and steep selloff is right around the corner. It's been holding on for a long time but unless gold can rally above 701 I think this is a bearish pattern that's set up right now.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow's economic reports are not expected to move the market so it will be left on its own to figure how it wants to respond to what it thinks the Fed will do next. I think they've made their intentions clear enough and unless we get "someone" who can jam the market higher again we should get at least a pullback tomorrow.

SPX chart, Weekly

The middle of the weekly Bollinger Band is at 1495 which places it half way between a 50% and 62% retracement of its recent decline. It would be typical for price to find resistance there after making the trek from top to bottom of the band. It's typical to see price bounce off the bottom of the band in this case, tag the mid line and then head down to new lows, pushing the bottom of the BB ahead of it. The latest decline is a change in character for the market since the August 2004 low and I believe it's our signal that the top is in, short the rallies.

It could be a little more volatile tomorrow morning as the market sorts out who's right and who's wrong about the future direction of the economy and therefore the Fed. Because we're right in the middle of what appears to be a correction of the recent decline, it could make 200-point moves in the DOW, like today, and not mean anything. It's going to be hard to find an entry and not get whipped out of your trade. These times require you to open up you stop wider and use smaller trade sizes (to keep the per trade risk the same). If you normally trade the e-mini futures, try options instead and try not to get spooked out of the intraday moves. If you normally play options and are finding it difficult to stay in, try trading the stock itself and give yourself a 5%-10% move before getting stopped out.

Interactive Brokers has sent a message out to all clients that they're raising the margin requirements for those index and stock futures experiencing a 4% or greater volatility. That's happening almost on a daily basis (and it's indicative of the tightening in credit even in the brokers).

I've said it before and I'll say it again--this is not a good time to be selling credit spreads. They're fine in a quiet market. Is this a quiet market to you? You need to trade differently in different markets and if you're not comfortable trading differently then step aside. Flat is always a good position when the risk side of the equation becomes too large. The majority of the time the market is consolidating/correcting and therefore you might not have to wait long. You might have to wait a month-cycle but I think that's less risky right now than hoping the market stays within a certain range. If I've got the bearish wave count correct then the next leg down will definitely tag your bull put spreads, even the ones rolled down and out into September.

Directional plays have their own challenges when it comes to stops. You wanted volatility, you got it. The hard part is now trading it. Hopefully the key levels I've provided will help you identify where you'll want to enter a trade to try to catch the move, either up or down. I continue to try to catch the turns in my intraday calls on the Market Monitor. I'll be back tomorrow night and we'll see if the pattern clears up just a bit more to provide some clues heading into next week. Good luck.
 

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