In other markets, bonds were down 3/4th of a point, gold rallied $6.00, crude was a tad lower at 25 cents while Euro made new highs.
Going forward, bulls should step in to support the S&P at 1512 / 1505 / 1485, while bears will hope to defend 1540 and 1555.
The S&P 500 chart above indicates a nice textbookish inverse head-and-shoulders, with a neckline at 1485. The “shock and awe” strategy adopted by the Fed saw the indexes gaining sharply on Tuesday. Dow Jones was up some 70 points before the rate cut and finally closed up 335 points. The head-and-shoulders bottom is a potent reversal pattern; however, the powers of the Fed was needed to complete the pattern and trigger a breakout. The typical target arising from this pattern will see us easily sailing past the lifetime highs on the S&P.
An old trader's adage says... the initial break is to be ALWAYS faded. Aggressive traders would have possibly used yesterday's opening spikes to buck the trend and initiate 'hit and run' shorts. Short term momentum remains overbought, although it has eased a bit yesterday. I expect today's trading to set up some divergence on hourly RSI which will likely coincide with the completion of a small wave 3 starting from the pre-rate cut lows. After the roller-coaster ride of the last two days, the indexes are likely to see more sanity emerging over the next couple of sessions. We expect a minor retreat before bulls muster up enough strength to take on the steely resistance at 1555.
Today we will see the initial jobless claims, leading indicators and the Philadelphia Fed report. While these are generally non-market moving, all the attention will probably be grabbed by Paulson & Bernanke's testimony before the “House Financial Services Committee” chaired by Barney Frank. Coupled with quadruple witching this week, traders and scalpers are likely to see some intraday volatility.
The Russell 2000 is our chart of the day... after a period of distribution starting April, it finally capitulated in July, mirroring identical drops in the other indexes. The initial decline found support around 750. The next six weeks saw the RUT toggling between 750 and 800 with bulls and bears alternatively taking turns in dominating proceedings. The greater-than-expected Fed rate cut this week saw the RUT finally break past the resistance at 800. After a long period of sluggishness, RUT finally seems to be gaining some momentum. However, it is probably too preposterous to call for a sizable rally here. Instead of jumping the gun... lets look at the rationale that we have postulated before about the underperformance shown by the Russell indexes.
The Russell group of indexes, by its very nature, are broad-based indexes. In a liquidity crunch, where the credit markets simply freeze up, small and mid-sized corporates are likely to find financing difficult to come by. While Countrywide avails of her credit lines and gets a bailout from Bank of America, its smaller peers are likely to find cash harder to come by. The high degree of leverage that corporate America has indulged in over the past few years does not help either, making financial institutions unwilling to lend unless they are compensated adequately for the additional risk. The lowering of the Fed funds rate, unlike what many perceive, is much less helpful to smaller companies.. corporates, unlike banks, borrow at “LIBOR + spread” rather than at the “Fed funds rate + applicable spread”. 3-month LIBOR shot up to multi-month highs after the credit market troubles came to light on August 7. Though Libor rates have eased a bit over the past two weeks (especially after the Fed rate cut), it still remains high relative to its recent past. As the BoE's Tucker noted today, banks have started to stockpile liquidity instead of lending. Banks still remain wary of the skeletons that may be lying 'out there' – sub-prime losses hidden in off-balance sheet SIVs (ironically, banks probably just need to look inward to gauge that... the health of investment arms of most banks are coming under suspicion, with nobody being spared).
Despite abundant liquidity, there remains little fluidity throughout the system. In such circumstances, small and medium sized companies will continue to face pressure in trying to access credit. A prolonged credit crunch would of course cause expansions to be shelved, buybacks to be put on the back burner, M&A frenzy of the not-too-distant-past to ease, etc. But while that dire situation is still some way off, investors are likely to prefer large cap plays which are likely to come out less hurt from this credit crunch. We do not expect significant out-performance from the broader indexes unless the prevailing credit crunch eases significantly.
Dont fight the Fed at home... or abroad!
While most of the attention has been focused on the dramatic rally in US equities, it is probably worthwhile to note the reactions from across the globe, especially emerging markets, following the Fed's generous dose of steroids.
We can sense several prayers clamoring for a long life for the Fed from all across the world!
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