9/23/2011
By Brian Sozzi, Research Analyst

I worked from home yesterday, and by early afternoon I had turned off the trading screen.  Just couldn't handle it anymore, had to detach myself from the pure red-filled insanity.  Fundamentals are worthless.  Commonsense is worthless.  The only thing one has at his/her disposal to navigate a sickening tape is the ingrained instinct built up through years of investing and trading.  This young fish has seen enough to know that when stocks are correlated in this manner, we break briefly below a key technical support level on the S&P 500 (early August lows), and officials in the EU are more inclined to talk than act that having downside protection in the portfolio is critical.  In fact, having cash is critical.  Now I am not saying these things to strike fear, this is the reality we are dealing with at the moment.  Have to carefully choose spots and be a realist, not think like an 85 year old alleged market veteran that believes valuations are too cheap to ignore.  I actually think my youth has helped me avoid horrible broad market and stock calls from the April peak as I am willing to accept circumstances hitting me in the face instead of relying on 30 year historical data pulled up from a Bloomberg terminal.

That said, the Fed's uber hyped Operation Twist, in addition to the accompanying language, was very poorly received by the market.  While the language was a clear downgrade of the economy following a downgrade on the August 9 meeting, the actual Twist itself will hamper the returns of pensions (among other domino effects) at the same time little incentive exists to save compliments of rock bottom interest rates. 

So What Happened?

At the August 9 FOMC meeting, the Fed downgraded its assessment of the economy's output potential.  We all saw it coming from the incoming macro data points and price action of the major equity indices.  Additionally, the Fed dropped a small-ish type bomb on the markets, and in the process flipped Ron Paul the bird, by stating its intention to maintain the Fed funds rate at extraordinary low levels through mid-2013.  Exceptionally low rates for nearly a two-year timeframe was not good enough for the markets initially (S&P 500 closed the session down).  Interestingly, though, the market hits its intraday low for 2011 on August 9, so this explicit language on rates did bring a touch of the wealth affect that the Bernanke Fed supports.  Wednesday's release said economic growth "remains slow", which equates to "considerably slower" as expressed on August 9.  The market's interpretation at the hook portion of the release is that despite full blown accommodative policy measures, economic growth has settled at a disappointing baseline.  Negative number one.

Negative number two centers on an obvious statement and what it means for the economy and a less obvious statement that deserves its share of attention.  Acknowledging "significant" downside risks to the economic outlook as voiced today is materially different in tone than solely muttering "downside risks."  To this not so casual markets observer, the statement implies that the Fed's actions, from QE1 to QE2 to supremely low rates, may still not prevent the economy from weakening further from that which is normal during this specific spot in a recovery.  The feelings of being unable to do anything, or the Fed being out of bullets if you will, married to political gridlock that has caused a fiscal policy logjam is risk appetite unfriendly.  Within negative number two, there is this nugget of wisdom by the Fed; inflation "appears" to have moderated as opposed to the August 9 comment that "inflation has moderated."  Dose of stagflation acknowledgement?  If it "appears" that inflation has moderated, it's as if to say it really hasn't, and this all arises when there are "significant" downside risks to growth.  No number two in the eyes of Mr. Market.

We ended up receiving Operation Dougie (or Operation Twist for you babyboomers/Fed historians), with the Fed intending to purchase $400.0 billion in Treasury securities to help bring down long rates.  Two takes include: (1) market wanted more; (2) program is in play for nine months, too long in this short-term minded market where EU news dominates; and (3) program implementation is not a done deal as it's being regularly reviewed.  Classic case of the market wanting XYX from the Fed and it only receiving X and the top half of Y.

The Wrap

The Fed Chairman once again succumbed to market forces.  We may be unable to tell now, but down the line the concept of moral hazard has to be thought about when discussing this Fed's litany of actions.  Stocks go down, the Fed acts, first via its thunderous language and then by way of actual maneuvers.  Stocks go up, the mood of euphoria feeds on itself, until it doesn't...and the Fed acts. 

Brian Sozzi
Wall Street Strategies

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