March 12th, 2008

Putting Fed’s Rates Cuts into Perspective

Most everyone is calling yesterday’s market the “best day in five years” (how can you not, it’s a statistical fact) and yet, to me, it feels similar to the market’s intra-day reversal on January 22.

Boy, do we have short memories. On that day, the Fed shocked the Market with a late afternoon, unprecedented 75 basis-point emergency cut plus a 75 basis-point cut in the discount window. Lest we forget, I’ll quote from one laudatory review of the action from a Reuters account of the action:

“The U.S. Federal Reserve, responding to an international stock sell-off and fears about a possible U.S. recession, cut its benchmark interest rate by three-quarters of a percentage point Tuesday, an aggressive move that came a week ahead of a regularly scheduled meeting of the central bank.

The Fed’s policy making group, known as the Federal Open Market Committee, lowered its target for the federal funds rate, which regulates overnight loans between banks, to 3.5 percent from 4.25 percent.

The move, unusual in both its scale and its timing, underscored the severity of the current strains facing the U.S. economy.

‘It’s a once-in-a-generation event,’ Mark Zandi, chief economist at Moody’s, said. In recent years, the Fed has rarely acted between scheduled meetings of the committee, and almost always in increments of one-quarter or one-half point. It was the biggest single cut since October 1984.”

The market had sold-off from the open in response to huge declines in other markets around the world. The previous day’s S&P 500 close was at 1325.89; the market opened on the 22nd at 1312.94 and by the time of the Fed’s announcement had dropped as low as 1274.29, or 3.89% from the prior close.

Within seconds of the announcement, the market began surging and hit a high of 1322.09, or 3.75% over the day’s low before closing at 1310.50 netting a 1.1% drop for the day. Over the next 8 trading days, the market tacked on an additional 6.48% before settling back (see chart below).

Yesterday’s gain was a nearly identical response to the Fed news of 3.71% from the prior close.

What’s most interesting is that both surges began at almost nearly the same levels although one was an intra-day low and the the most recent a prior day close. This is where charts are useful:

Note the that what many were touting as a “symmetrical triangle” bottom has morphed into what many will soon call a “channel”, or “double” or “W” bottom. There’s nothing that would make this into a bottom except if the market actually reverses and breaks through around the 1400 level and crosses back over both the 60- and 90-day moving averages.

Furthermore, note how far the market has actually dropped and the scale of the reverse that’s required before it can “safely” be said that a base has been put in and that a sustained, momentum-driven bull market can begin. Yes, the market might go back up to 1400, a nice 6% move from here but I, for one, wouldn’t start betting the ranch. It might be a quick trade but the scale of the damage that’s been done to the market since the peaks in 2007 requires that you have to maintain perspective.

Let’s take the graph above and zoom out, quite a bit out:

Note how small yesterday’s move seems within the scope of the market’s long-term challenge. The struggle began last year when the market was trying to scale the old 2000 market peak. Yes, the sub-prime crises may have been the percipitating factor and there’s no doubt that the first inkling in July, 2000 has led to a huge amount of damage and 1) more damage is coming and 2) it will take months, perhaps years for a new bull to carry the market into new all-time high territory.

I’m not worried if I missed yesterday’s move and if I’m still heavy into UltraShorts and commodity and forex type ETFs. I’ll have many opportunities to jump back in with both feet with more opportunities and less risk.

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