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December 16, 2008

Out of Ammo

We certainly live in interesting times. Instead of publishing a target rate for Fed Funds, the FOMC today announced a target range of 0 to 1/4%. The translation is that they basically cut the rate to zero, but since it is technically difficult to target a 0% rate, we were given a diminutive range. The Fed is now completely out of ammo on the rate front, and this act of desperation totally vindicates those of us who were long ago professing how bad things would get. It also highlights how bad things are, and I don't believe for a minute that free money from the government will change anything except the magnitude of inflation we get to enjoy down the road. The important bits of information, though, come to us behind the headlines in the form of market reactions to the news. Let's dig in.

First, it is useful to note the unusual characteristic of today's post-Fed reaction, being that the initial reaction... in this case upward... was not reversed a short time later. I can't remember the last time a rate change was not accompanied by a large whipsaw in afternoon price action. Instead of a quick reaction lower, we saw price rally straight into the close. Chalk one up for market strength.

The cut was obviously deeper than expected since an already-tanking dollar tanked further after the announcement. The U.S. Dollar Index has now dropped nearly four points in two days. "Startling" is an insufficient adjective for such a move, but it is the first one that comes to mind. The index has now unwound practically to the point anticipated for the entire mid-term rally.

dollar chart

Only a couple weeks ago, I was anticipating that a multi-month stock rally would see the SPX to 1250 while the dollar sank to 80 or thereabouts. With the buck already sitting on 80, something has to be reconciled. Will the stock rally end earlier than anticipated? Will the buck unwind its entire rally from July? Or perhaps the inverse relationship between stocks and the dollar has been disconnected? Unfortunately, there is no clear evidence for any of these cases. We'll just have to wait and judge further action.

A true disconnect has come in the form of the action in crude oil. With everything working in its favor... a sharp drop in the dollar, production threats from OPEC, and healthy moves in other commodities like gold... crude has seen three straight days of weakness. Normally, price failing to react positively to strongly positive events is a very bearish sign. However, with oil so massively beaten, I am skeptical. There are obviously many minds trying to get themselves around oil's action, and I simply think the recent anomalies are a product of the market doing what it does best... shaking off weak hands before a massive move. And what a job those market gods are doing. I guarantee you many folks are seeing the same setup I described for the dollar above and are reticent to add oil poistions for fear the buck will bounce soon. If oil turned and rocketed straight higher from here, it would surprise an army of traders, including prescient ones.

Let's wrap up with an S&P 500 chart.

index chart

You now see why I only dropped the aggressive layer of my long position. When the trend is up, which I believe to be the case, the surprises will be on the bullish side. Given that a few of our indicators are still stretched, I do not expect the SPX to punch through the 65DMA on its first run. Besides, a useful rule of thumb says that the flatter the slope of an important MA, the more likely price is to puncture it. A plunging 65DMA fits our postulation that it will deflect price on the first run.


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