The Fed lowered its estimate of economic growth and promised exceptionally low rates through mid 2013. That long-term promise replaced the extended period language and caused an immediate drop in treasury rates.

Market Statistics

The Fed meeting was the big news today. The Dow recovered from its slide on Monday with a +228 point rally by mid morning but declined into the impending Fed announcement at 2:15. After the announcement the Dow dropped sharply to a -220 point loss. After a period of high volatility the index rebounded +649 points to close with a +429 point gain. To say the market was volatile would be an extreme understatement.

The Fed did lower its economic outlook saying it has been growing "considerably slower" than the committee expected. Other comments included, "Household spending has flattened out" and "unemployment rate has moved up." They also said the impact from Japan appeared to be fading. Inflation moderated as prices of energy and commodities declined from their earlier peaks. Longer-term inflation expectations remained stable.

Also, "the committee now expects a somewhat slower pace of recovery over coming quarters" and "unemployment rate will decline only gradually."

Link to Fed Statement

The most important sentence was "downside risks to the economy have increased." The Fed is acknowledging inflation is no longer the biggest worry and there is the potential for a recession if conditions don't improve soon. To further stimulate the economy without actually taking any action the Fed said it would keep rates exceptionally low for the next two years and continue reinvesting funds from the payoff of existing securities into new securities. This is a continuation of QE1 and QE2 without committing any new funds. They will simply keep the size of the Fed balance sheet at the same level by reinvesting funds from maturing assets. Nobody expected this to change.

There was no talk of a QE3 program and there were three dissenters, Fisher, Plosser and Kocherlakota. Those three inflation hawks wanted to keep the extended period language rather than establish a firm timeline for keeping rates low. They are afraid the economy could begin to accelerate and the Fed would be stuck at near zero interest rates that would dramatically feed inflation in an accelerating economy. Ironically these are the same members that voted to remove that language in prior meetings because they thought the inflation risk was rising. This change in posture should be a clue to the group mindset.

Apparently the rest of the committee, the seven remaining members, were concerned enough about the potential for a return to recession that they wanted an insurance policy in the form of a guarantee of low rates for the next two years. With a guarantee rates will be low, businesses can plan for expansion knowing their cost of capital will remain low. Banks will be free to invest appropriately knowing rates won't be rising.

The stock market benefits because investors are faced with nearly zero returns in bonds and treasuries for the next two years and will be forced to move money to equities in order to get a return higher than the inflation rate. There are hundreds of stocks now paying dividends well over the 10-year treasury yield. These stocks will be the favorite investment vehicle in our slow growth environment.

The market drop after the announcement was clearly a sell the news program trade. Some large fund(s) were still looking to exit some positions and expecting a post meeting pop to provide an exit point. Once the sell the news trade was over the market took off and closed at the highs of the day.

Even though the Fed lowered its growth outlook they are still predicting growth. Slow growth is still better than no growth so bargain hunters appeared in volume and the shorts were forced to cover. Some analysts were negative on the news saying this was the equivalent of a forecast for two years of slow growth.

There is one caveat here. The actual Fed statement says, "Conditions are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013." There is no hard promise they will hold this line. If economic conditions improved significantly they can change the game plan.

If the Fed sticks to its statement on rates this will not expire until well after the 2012 elections and until the end of Bernanke's current term as Fed chairman. This takes the Fed somewhat out of the political arena for the 2012 cycle.

The Fed basically told the markets there would not be a QE3, a TARP 2 or similar asset purchase program. The Fed promised the market low rates until the economic recovery occurs but no additional help should be expected. Bernanke's speech at Jackson Hole later in the month will be very critical to further interpretation of the Fed outlook and expectations.

The yields on the various bonds collapsed. The ten-year note yield declined to 2.17% and the lowest level since January 2009. The dollar collapsed and gold prices rallied to $1751 but that was that was well off the intraday high of $1782.50.

Ten-Year Note Yields

30-Year Bond Yields

Gold Chart

The only other economic report for the day was Productivity and Costs for Q2. Nonfarm business productivity fell -0.3% when the consensus was a +0.2% increase. This was the second consecutive quarter of productivity declines after rising +2.2% in Q4. The Q1 decline was -0.6%. Productivity declines with hours worked increase more than products produced. Hiring increased slightly in Q2 but growth was soft. Businesses added to staff in anticipation of the recovery but it failed to appear in any meaningful way.

Moody's Productivity Chart

The economic calendar for the rest of the week is busy but most of the reports are generally ignored. Jobless claims and Consumer Sentiment are probably the two that will garner the most attention. There are whispers of a potential jobless claims number under 400,000 and that would be mildly bullish. However, sentiment could see a significant decline that reflects the last week of the high profile debt debacle and the first two weeks of the market correction.

Economic Calendar

In other news there were a several earnings reports of note beginning with Disney (DIS), which reported earnings of 78-cents compared to estimates of 73-cents. Revenue rose +7% to $10.68 billion. Revenue from theme parks rose +12%. Apparently the high gas prices did not keep people home and business was good. The fourth Pirates of the Caribbean film and Cars 2 helped Disney to a breakeven performance at the box office. Other films were less well received. The Bachelorette on ABC was a hit with the final shows at the top of the most watched list according to Nielson. Disney shares rallied +5% into the close but gave back some of their gains after the report.

Beazer Homes (BZH) posted a loss of 80-cents compared to estimates for a loss of 42-cents because of a sharp decline in closings. New home sales rose +23.7% but revenues were still light. Prices did rise and inventory is declining so maybe there is light at the end of the tunnel for new home sales. Shares of Beazer declined -6%.

Cablevision (CVC) reported earnings of 31-cents that rose +9% but they missed the street estimates of 42-cents and shares were crushed for a -13% loss. The earnings were complicated by the spin-off of the AMC networks last month. The company also lost 23,000 video subscribers in competition with Verizon. Cablevision only added 5,000 broadband subscribers and that was the lowest number in three years. They also said the weak economy was pressuring subscribers in lower income areas.

AOL posted a smaller loss in Q2 even though revenue fell due to an accounting charge. The company said advertising revenue increased for the first time since 2008. AOL is expanding its acquisitions of content websites like the Huffington Post, which it acquired for $315 million earlier this year. That brings their content stable to more than 50 websites. For Q2 AOL posted a loss of -11 cents but there were 15-cents of charges. Without the charges AOL would have earned 4-cents. Subscription revenue fell -23% to $201 million as fewer people access AOL through the dial-up service.

AOL Chart

Fossil (FOSL) fell -13% after reporting guidance that missed estimates. Fossil expects earnings of $4.44 to $4.50 and the analyst consensus was $4.63. The company said costs were rising rapidly with labor rates in China up +32% this year alone. They also complained that the price of silver had more than doubled. Earnings were 73-cents and 2-cents below analyst estimates.

Fossil Chart

Earnings due out on Wednesday include CSCO, M, MBI, RL and RATE. Cisco will be the highest profile event given the recent guidance warnings in the networking sector. Cisco shares were flat on Tuesday. Given the recent high volatility moves after their earnings I am not surprised traders would be hesitant to jump into those shares.

Apple (AAPL) became the U.S. stock with the largest market cap for a brief period on Wednesday. Apple shares rose to $374.01 a share for a market value of $346.7 billion. Exxon rallied to $71.64 and a market cap of $348.3 billion. For a few minutes Apple held the top spot before oil prices rallied into the close and pushed energy equities higher. Apple will move into the top spot eventually and likely remain there for many months. However, as we get closer to peak oil and crude prices move back into triple digits Exxon will move back into the top spot.

Oil prices recovered from a very negative overnight session. Crude prices dropped into the $75 range overnight as Asian markets opened significantly lower. As the overseas markets recovered oil prices began to rise and closed well off their lows. Crude is trading tonight at $81.35 and rising. That is a six-dollar rebound and that produced some big winners in the energy sector. National Oilwell (NOV) gained +$6, COG +6, CRR +9. OXY +5, etc.

OPEC updated their monthly oil demand outlook and predicted a 1.2 million barrel rise in demand in 2011 and another 1.3 mbpd in 2012. Demand was expected to continue growing from Asia and Latin America while austerity programs in Europe and slow growth in the USA restraining demand growth in those regions. China's oil demand slowed in June, the first time in eight months, but they are still expected to show 6.5% demand growth for the full year. Demand for 2012 is now expected to be 89.4 mbpd, a downward revision of only 19,000 bpd over their last estimate. Slower demand growth is still demand growth. OPEC said production in July totaled 88.3 million barrels. That was an increase of 800,000 bpd over June thanks to increases from Saudi Arabia, Kuwait and the UAE. Nearly every analyst believes OPEC nations are pretty close to full capacity today and that means adding another 1.3 mbpd in 2012 is going to be a challenge. Unless the world falls back into recession oil prices are going higher longer-term.

U.S. WTI Chart - 90 Min

The S&P declined -6.6% on Monday for the worst single day decline since December 2008. The Dow declined -634 points and the sixth biggest one-day decline ever for the Dow. The S&P rebounded +6% off its intraday lows on Tuesday to close well over 1150 at 1171 after trading down to 1101 intraday. The closing gain of +4.7% was the best gain since a +7% day in March 2009. Financials rallied +8.2% after a -10% decline on Monday.

All of this volatility came on extremely high volume. On Monday's decline there was 16.55 billion shares of volume with 15.84 billion in down volume. Clearly a capitulation day. Tuesday's rebound, despite the intraday dip, had volume of 16.51 billion shares with 15.24 billion is up volume. As a trader you want to see at least the same amount of volume on an upside day as a downside day and we have not seen that recently until today. The internals completely swapped directions and in theory that is a bullish sign.

Market Internals

Translating theory into reality is always tough for the markets. In theory Tuesday should have been the start of a rebound and a sign the bottom has arrived. In reality what we saw was a monster short squeeze where the millions of traders short various ETFs were forced to cover.

Fortunately that is how most correction rallies begin. The key will be what happens on Wednesday. I would expect Asia to open higher and have that translate into a higher open for the U.S. on Wednesday but there are probably some sellers still lurking on the sidelines. The technical damage is far too great for a rebound to just begin with a +600 point intraday swing and then continue to blast higher. There will be some sellers who want to get off this roller coaster. Once the rebound appears to lose traction I would expect a new round of sellers to appear. If the bulls can hold off that attack and make it through the rest of the week then we can start looking at long-term predictions again.

The S&P dipped to 1101 after the Fed announcement and while 1100 is not specifically a critical support level it is definitely psychological support. To drop from 1350 to 1100 in three weeks is a terrible nightmare for traders they may relive in their dreams for weeks to come. The key for the rest of the week would be support at 1120 and a Fib retracement level for the QE2 rally. I would hope 1150 will hold as a key support level but hope is not a valid trading strategy.

If you are bullish I would be careful about buying the dips until we have another support test that tells us where that support really is. That should appear during an intraday dip over the next couple days. Initial overhead resistance is 1175 from November and then 1215 from Friday's intraday bounced that failed.

S&P Chart

The Dow fell to 10,604 before rocketing higher to close at 11,239 and another 600 point swing. Those are becoming relatively common over the last couple weeks. The increased volatility is a sign of a bottom trying to form. Shorts are not as aggressive and they are exiting positions quicker. The bulls may not be convinced the bottom is in but with the S&P trading at a PE of 11 there are plenty of bargains available. Fund managers scrambling for cash last week may start putting some of it back to work on stocks that are down 20% to 30% in just a couple weeks.

The Dow closed just over near-term resistance and futures are up late in after hours. Typically after a blowout day the futures would be negative from traders protecting profits and preparing to exit the following day. Being positive is a mildly bullish sign but there is plenty of darkness left before morning.

Dow Chart

The Nasdaq rebounded a whopping +151 points from the lows at 2331 to close at 2483. Those numbers are simply amazing and demonstrates the power of a serious short squeeze. Google gained +27 and Apple +21 as examples. That also only counts the gain for the day and not the rebound from the intraday dip.

Nasdaq 2500 should be round number resistance on Wednesday and it could be a decent barrier. Time will tell. Nasdaq futures are up +8 points but in this market that is about five heartbeats. There is no conclusion you can draw from today's trading other than the strong gain off the bottom will be harder to erase.

Nasdaq Chart

The Russell tested support at 650 at the open and then again after the Fed announcement. The second test was followed by an unbelievable +7% gain, +8.75% off the intraday lows. That kind of move is astounding and illustrates how heavily shorted the small caps were. The chart is extremely ugly but the strong rebound is encouraging.

Russell Chart

I would like to think the rebound will continue on Wednesday but so many technical and psychological levels have been broken we are trading in uncharted waters. Normally a monster rebound like today would be sold as the remaining sellers celebrate a chance to exit at a higher level.

Wednesday's market action could be very tentative as buyers and sellers test each others resolve. Rather than simply go long on any continued rebound I would rather hang back and wait for a pause for some profit taking. However, I am sure we have all seen rallies that begin with a strong short squeeze simply continue unabated for days as disbelieving shorts continue to sell into the rally expecting the decline to return.

Whether your bias is long or short for Wednesday it would probably be a good idea to watch the opening signs before stepping into the traffic.

Jim Brown

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