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Editors Picks The Fed-Dependent Market
Editors Picks The Fed-Dependent Market 
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| The Fed-Dependent Market |
| Thursday, 13 December 2007 | ||||||||
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Dear Reader, There’s a phrase that traders use from time to time that applies well to this market – “rip your face off.” We use it to refer to the volatility the market has seen over the past two days thanks to the decisive (tongue firmly planted in cheek) action from the Fed. For those who don’t make a habit, or living, of looking at minute-by-minute market activity, the volatility has been off the charts. And for those who do, it’s been a killer. At the root of the volatility is the Fed. On Tuesday, the FOMC dropped key interest rates by 25 basis points in an effort to stabilize the market. But stocks reacted with a 300-point sell-off on the Dow, as investors made it clear that they wanted … and expected … more. Of course they do. The only thing the market has going for it is a loosening monetary policy. Think of it like steroids. You know that they’ll help enhance performance, but you also know you’ll end up paying the price physically (in this case fiscally) and then testifying in front of Congress (now that’s kind of funny). I’ve said it before and I’ll say it again: IT IS HARD TO BE BULLISH ON MONETARY POLICY ALONE! Take the Fed’s recent three cuts to interest rates out of the equation and what do you have? Questionable consumer spending, slowing employment, slowing global growth (except in China where the economy will continue until they dowse the Olympic torch), slowing earnings growth … you get the idea. We’ve heard, and for the most part believe, that it’s a losing proposition to fight the Fed (short the market). I heard an interesting discussion on the radio while driving into work today. A commentator pointed out that historically the market’s performance after three consecutive rate cuts was split down the middle. Half of the time the market took off, the other half it tanked. Now, most of you know I like to quantify things like this to get a good feel for why the results come out the way they do. It’s what provides a trader with a true edge. But in this case, I don’t think it’s necessary to break down the numbers. A seemingly simple explanation may apply. Any rate-lowering cycle has a “first three” and a “last three” interest rate cuts. It’s not a far jump to conclude that the first three come because the economy is slowing and the market is headed for some turbulent times. Care to guess what’s going on with the economy when the last three occur? It’s improving, of course. Otherwise, the cuts would continue, moving the “last three” back until the economy had turned around. Would you have wanted to be fully invested when the last cut of the “first three” happened? Nope. My point is that trying to invest solely on forecasting what the FOMC will do is a fool’s game. The simple fact that the market is pricing in, and likely to get, two or more rate cuts should serve as a warning sign. Tuesday’s selling represented nothing more than opportunistic traders taking money out of the market in the wake of the FOMC decision. It was classic “sell the news” trading. Those who watch the market closely saw this coming from a few miles away. Our own commentaries over the past few weeks have pointed to the overwhelming potential of a sell-off.
So, is the market a losing proposition right now? No, it rarely is. Those who are nimble enough can “time” good entries and exits to shave a few points out of the short-term trends. Those experienced in trading options should be able to find the hidden gems in the market and profit from them. For others, this is a time to trim some profits from their portfolios. It’s also time to appreciate the value of a larger-than-normal cash position, as volatility is likely to persist so long as the Fed tries to exercise a cool hand on the market. Have a great trading week. CJ P.S. To let me know what you thought of today's article, send an e-mail to: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
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