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Back to the Future


It's a tale of two tapes. Where will markets go after the FOMC?


"Life comes down to a few moments. This is one of them."
--Bud Fox, Wall Street

Markets like to peer ahead. Today, they won't have to.

With the FOMC meeting upon us, the kitchen sink has been brought to the forefront of our collective psyche. Inflation in things we need, deflation in things we want, credit dependency, cumulative imbalances and the notion that we must choose between asset class deflation and dollar devaluation all seems to settle down to one singular question.

After the Federal Reserve cuts interest rates 25 basis points-which is less aggressive than what we've seen since the financial crisis began-will the collective perception be that it's proactively operating from a position of strength or defensively posturing as a function of need?

In other words, given Fed Funds have already been slashed 300 basis points since September-and assuming an implied floor may reside at 1% due to the stated desire to remain above levels last seen in Japan-when will conventional wisdom begin counting the bullets left in the gun?

To be sure, interest rates are simply one weapon in Ben Bernanke's war chest. We've spoken at length about how the interwoven market machination has passed the point of no return and the stakes are such that policy makers can't afford to fail. The closed-door meeting today to discuss expediting the Fed's ability to pay interest on bank reserves speaks to that point.

Through that lens, the magnitude of today's cut pales in comparison to the influence of auction facilities, lending windows, working groups and other policies currently in play. Therein lies the subtle yet important distinction when weighing the reaction to today's news. While the structural metric will be in the spotlight, the psychology surrounding it will tell the tale.

The stock market is meandering around several key inflection points. S&P 1405, DJIA 12800, Russell 735 and Transports 5000 are being monitored by reactive money managers around the land, a fact not lost on the wizards behind the curtain. They know all too well that in the absence of clarity, technical perception is reality on Wall Street.

They know all too well that the stock market is the world's largest thermometer and the eyes of the world are upon it.

Last week, while discussing the state of affairs on Minyanville, I was asked about volatility levels. The VXO-widely perceived to measure anxiety-is 47% lower than where it was on March 17 when Bear Stearns (BSC) imploded and fear swept the Street.

The bull case was offered, which wasn't a shocker given the 10% rally off the lows. "Volatility is the opposite of liquidity," I was told, "and we've seen a trillion dollars injection by the government. Besides, if you pull back the historical lens, you'll find that the VXO has a long history of living at the lower levels we're just now starting to approach."

I agree with both sides of that statement. The potential caveats in extrapolating them are the cumulative imbalances that continue to build and the dollar, which is down almost 40% since 2002. Indeed, one could argue that in terms of pressure percolating under a seemingly calm financial surface, the sum of the underlying parts may soon overwhelm the whole.

A few Random observations as we get ready to exhale at 2:15 EST:

  • Liquidity will be thin and volatility fierce on either side of the announcement. Keep that in mind if you're trading and reduce the size of your positions in kind.

  • The first move following the FOMC announcement is typically the false move.

  • The path of maximum frustration in equities may include a false breakout above S&P 1405 before supply begins to fill in.

  • The rotation out of commodities should continue, particularly if the dollar catches a bid due to the perceived pause by the Federal Reserve.

  • The oil drillers and gold miners may have double jeopardy as a function of underlying commodity weakness and retail traders often using them as a proxy for exposure to the space.

  • The financials enjoyed a relief rally after the market machination didn't completely seize up. At a point, investors will shift their focus to the massive issuance in the sector and its dilutive effect on earnings.

Why wasn't the equity sell-off more severe given the risks in the system. I would offer that it would have been if not for massive government intervention. Mind you, I'm not rooting for dire times or market spirals. I'm simply stating that in order to effectively navigate this market, we must understand the rules of engagement have shifted and unseen influences remain in play.

With the structural, technical and psychological metrics ready to collide, volatility is about to uptick in a major way. The current juncture is akin to a giant game of chicken, with powerful agendas on one side and cumulative concerns on the other. Something is going to give and it'll likely happen this week.

My positions, as they stand and subject to change, are two-sided. I'm long a handful of situations-turnaround plays stocks such as Gannett Inc. (GCI) and McClatchy Co. (MNI) that are on their heels and hated by the analyst community-along with a spate of gamma, or volatility, as I pick short-side spots in the financials and commodity based plays.

These are uncertain times and our financial fate will only be obvious with the benefit of hindsight. As the market is forward-looking and our performance is real-time, the onus is on us to intelligently manage risk and allow an ample margin for error.

It's certainly not easy but it's not impossible either. With a little luck and a lot of discipline, we'll find our way to better tapes and easier trades.

Good luck.


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Positions in GCI, MNI
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