VIX Bounces Off 50-Day

by Bespoke Investment Group

As we noted last night, the S&P 500 was stymied by its 50-day yesterday. At the same time, the VIX volatility index has bounced off of support at its 50-day. Higher levels in the VIX generally coincide with a decrease in equity prices, so market bulls are hoping this is one bounce that doesn't hold.

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FOMC STATEMENT AND ANALYSIS

by Cullen Roche

Here’s the full FOMC statement. I highlighted a few pieces which I’ll discuss below:

For immediate release

Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.

The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time.”

The biggest announcement in this statement is “significant downside risks” to the economy. The Fed is becoming increasingly aware of their impotence. This could actually prove to be positive as Bernanke is likely to lean increasingly on Congress for aid in his fight against unemployment. But let’s not jump to conclusions. The bottom line is, this economy is very weak and is likely to remain so regardless of what the Fed does.

Operation Twist was basically as expected. They are buying $400B in long bonds and selling $400B in short bonds. It’s balance sheet neutral. Not that this matters a whole lot. As I’ve previously stated, monetary policy works by targeting rates. The Fed would have needed to say, “we are a buyer of 10 year bonds at 1%” in order for this to “work”. They didn’t do that. So, we can expect a lot of shuffling of the Fed’s balance sheet, but ultimately, these transactions lack a real transmission mechanism through which they can impact the real economy. In other words, this program should NOT put downward pressure on longer-term interest rates and SHOULD NOT help make broader financial conditions more accommodative.

The MBS purchases are interesting and they’re a slight change from past policy. I discussed this last year when I said this was one of the eventualities of QE2:

“He [Ben]wants to be fully prepared in case the banks relapse so he can step in with a sizable bank bailout. So, don’t be one bit surprised this week when Mr. Bernanke announces a small round of Treasury purchases with the option to buy MBS in the future. In all likelihood, this program will remain open until it’s clear that the U.S. economy is sustaining recovery and another bank meltdown is off the table. Don’t be fooled into thinking that this is some economic panacea.”

The Fed is likely disturbed by the recent house price declines and the deterioration in credit markets. As we saw during QE1, MBS purchases are an effective form of fighting a potential balance sheet deterioration and credit crisis. In this regard, the Fed appears proactive. That’s a positive. On the other hand, we shouldn’t sugarcoat this – this helps the banks and not the consumer via the mortgage market as the Fed press release implies – and yes, this is still a consumer driven balance sheet recession and NOT a banking crisis. The MBS purchases don’t generate economic growth, but could possibly help fend off credit fears. Unfortunately, the repurchases aren’t large enough to move the needle much.

In sum, this policy change doesn’t change much if anything. The Twist won’t “work” in reducing rates and the MBS purchases are an interesting and possible effective proactive measure (but not a growth measure!). The most interesting part of the statement is the “significant” economic downgrade. Ironically, the Fed might get their lower rates via a worsening economy and the lack of effective policy. The 10 year is dropping to 1.87% as I type!!

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Operation "Old Twist" ...

by Kimble Charting Solutions

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Don't Buy Stocks at These Levels

by Tom Aspray

With several key warning signs showing up on the charts, risk is high for new buying, and more favorable entry points are likely coming soon for the major stock index ETFs.

Stocks gave up their early gains on Tuesday, and the reversal was the most pronounced in the tech-heavy Nasdaq Composite. The stock index futures are lower in early-Wednesday trading and the markets may be quiet going into the widely anticipated Federal Open Market Committee (FOMC) announcement this afternoon.

Overseas markets were mostly lower and the short-term technical studies do suggest that the rally has stalled. The weak action in crude oil is also a concern. As I pointed out a few weeks ago, there is a nice correlation between crude oil prices and the S&P 500. The November crude oil has turned lower over the past few days and volume has increased on the decline. A break below the support at $83.40 should trigger heavier selling.

Of course, a rally to stronger resistance in the $125-$127 level in the Spyder Trust (SPY) is still possible, especially with the FOMC announcement, but the risk on the downside does seem higher.

The most negative interpretation is that the entire rally from the August lows is just a bear flag which will be followed by a drop to and/or below the August lows.

An alternative interpretation is that we will see a “soft landing,” which implies a decline to the $112-$115 area in SPY. This is consistent with both the improvement in the Advance/Decline (A/D) line and also the increase in bearish sentiment.

Another drop would help to increase the level of pessimism, which is needed to fuel a more sustainable rally. Let’s look at the evidence.

Click to Enlarge

Chart Analysis: The daily chart of the Spyder Trust (SPY) shows Tuesday’s failed rally attempt. There is next support in the $116.70-$118 area with the lower boundary of the flag formation, line b, in the $115 area.

• A close below last week’s low at $114.05 is likely to trigger heavier selling with the August lows at $110.27
• The 127.2% Fibonacci retracement target is now at $106.50
• The McClellan Oscillator formed significantly lower highs on the last rally and has turned down. It is now back below the zero line and a break of support at line c will signal a further decline
• There is initial resistance for SPY now at $122-$123.40

The daily chart of the Nasdaq Composite shows that it has had a much more dramatic rally from the August lows, as it has surpassed the 50% retracement resistance at 2608.

• The upper boundary of the flag formation, line d, is at 2664 with the 61.8% Fibonacci retracement resistance at 2678.
• The McClellan Oscillator has formed a negative divergence at the recent highs, line f. It has now dropped back below the zero line and a break of support at line g would confirm the divergence
• There is initial support at 2550 with the lower support from the flag formation (lines d and e) in the 2490 area
• There is a potential double bottom on the charts in the 2330 area

Click to Enlarge

The PowerShares QQQ Trust (QQQ), which tracks the Nasdaq 100 Index, exceeded the upper resistance from the flag formation on Tuesday (line a), but then closed lower, which is a short-term negative. The 61.8% retracement resistance at $55.88 was decisively overcome on the recent rally, which was a positive sign.

• Initial support is now at $55.30 with further support at $54.60. The uptrend, line b, is in the $53.50 area
• It would take a close below the September 6 lows at $51.91 to signal a test of the August lows
• The Nasdaq 100 A/D line overcame its downtrend, line c, last week, which suggests the A/D line may be bottoming
• The A/D line numbers on a decline will be important, as the September lows in the A/D line need to hold to set the stage for a new uptrend
• There is major A/D line support at the August lows
• There is resistance for QQQ at $57.35-$58.00

The iShares Russell 2000 Index Fund (IWM) continues to act the weakest, as the recent rally peaked at $72.03, well below the prior high at $73.89.

• The uptrend from the lows, line d, is now at $66.40 with additional support at $64.57
• The A/D line on the Russell 2000 looks the most ominous, as it made lower lows last week, line f. The down-trending channel (lines e and f) is a sign of a weak market
• It would take a move above the prior peak and a break of the downtrend to turn the A/D line positive

What It Means: The short-term technical outlook shows signs of deterioration, and while that does not mean that stocks have to drop immediately, it does mean that a further rally should be carefully watched.

More importantly, it suggests that those who are looking to buy stocks or ETFs should be able to buy lower, and the tech sector is still my favorite destination for new buying. I favor the “soft-landing” scenario but will be watching the market internals closely.

How to Profit: If you did not lighten up on the weak stocks in your portfolio when SPY reached the $121-$122 area, I would not wait any longer.

For those looking to hedge, selling options against existing positions looks most favorable, or else consider an option spread strategy since put premiums are high.

Alternatively, traders could buy the ProShares Short S&P 500 ETF (SH) at $43.36 or better with a stop at $41.72 (risk of approx. 3.7%). Sell half the position at $45.56 and raise the stop on the remaining position to $42.88.

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ROSENBERG: 10 REASONS NOT TO BE SHORT IN FRONT OF THE FED DECISION

by Cullen Roche

The usually bearish David Rosenberg of Gluskin Sheff is sounding bullish on the basis of more expected Federal Reserve action. In today’s research note he explains why he believes the Fed will act more aggressively than investors think and says the S&P 500 could even rally to “at least” 1250. He provided 10 reasons why investors don’t want to fight the Fed today:

1. Just go back to August 9th. The Fed was supposed to make a more emphatic comment in the press statement about “extended period” as it pertained to the length of time the Fed would stay ultra-accommodative on the rates front. Bernanke went much further than anyone thought with his pledge to keep rates at the floor to mid-2013.

2. Ben Bernanke has shown repeatedly that he is willing to take risks and be very aggressive.

3. Everyone knows the Dow finished the August 9th session with a huge 430 point gain after the FOMC press statement was fully digested. Not only that, but when Bernanke held his two day meeting in Mid-December of 2008 and unveiled QE1, the Dow soared 360 points. And last November, the day after the two-day meeting when Bernanke made it clear in his Washington Post op-ed article how key it was to ignite the stock market, the Dow jumped 220 points. It may all be just for a near-term trade, but in an industry where every basis point counts, who wants to be short in front of that?

4. At that August meeting, we know both from the statement and minutes that additional rounds of unconventional easing were discussed. And Mr. Bernanke made it very clear at Jackson Hole that they would be on the table again the coming meeting.

5. The Fed would like to be out of the picture during the election campaign (especially if Rick Perry ends up winning the GOP nomination).

6. The Fed has cut its GDP forecast at each of the past three meetings.

7. The stock market is actually little changed from where it was at the last meeting and we know based on the Washington Post op-ed, that it is equity valuation (specifically the Russell 2000) that Ben wants to see rally. Sanctioning lower bonds yields is just a means to that end.

8. There is no fiscal stimulus to bolster the economy, with the odds very high that the Obama jobs plan – some in his own party object to – will be dead on arrival on the House floor. The Fed is the only game in town.

9. Financial conditions have tightened nearly 100 bps since the spring and deserve a policy response.

10. Bernanke announced at Jackson Hole that this coming meeting was going to be a two day affair, not one day. The last time he did this was back in December 2008 and that was when he invoked QE1. There has to be a reason why it is two days, and it must be because he wants to build the case for three dissenters. The Board is being sequestered for a reason!

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'Italy's Chief Problem Is Its Own Government'

by Mary Beth Warner

Prime Minister Silvio Berlusconi blasted Standard & Poor's on Tuesday, saying its downgrade of Italian debt was politically motivated. German commentators tend to agree, but they say the real problem is Berlusconi himself.

Who is to blame for Monday's downgrade of Italian debt ? Is it Prime Minister Silvio Berlusconi , who has shown a marked hesitancy in implementing tough belt-tightening measures? Or is it Standard & Poor's itself? 

After all, the economic data cited by the ratings agency in its Monday evening announcement that it had decided to drop Rome's credit rating a notch was hardly new. The world has known for years that Italy was highly indebted.

The answer, of course, is that it may not really matter. The fact that investors are quickly losing confidence in Italy is hardly a secret: Interest rates on Italian sovereign bonds have been steadily climbing for months. Furthermore, should Greece become insolvent, as most believe it will, the state of Italy's finances may well pale in comparison to the economic waves coming from Athens.

Indeed, International Monetary Fund chief economist Olivier Blanchard likewise indicated that the global economy faces larger problems than how Standard & Poor's view Italy. He warning on Tuesday that the world is in a dangerous new phase and told reporters that "there is wide perception that policy-makers are one step behind markets." He said Europe "must get its act together."

Still, how Italy deals with its debt difficulties will be a major factor in European efforts to solve the debt crisis. And Standard & Poor's indicated it has little confidence in Berlusconi's leadership. The agency's report said the move "reflects our view of the Italian economy's weakening growth prospects and our view that Italy's fragile governing coalition and policy differences within parliament will likely continue to limit the government's ability to respond decisively to domestic and external macroeconomic challenges."

In Germany, representatives from Chancellor Angela Merkel's governing coalition downplayed the news or pinned the blame on the Italian government for not doing more. Reuters reported Tuesday that German Finance Minister Wolfgang Schäuble, in discussions with colleagues, said the downgrade showed Italy has a political system that is no longer considered sufficiently serious.

German commentators on Wednesday tend to agree.

The center-left Süddeutsche Zeitung writes:

"Italy's chief problem is its own government. Berlusconi and his team act as if they are being besieged from all sides: from judges, the opposition, and financial markets. That does not build trust"

"Everyone knows that [Italy] cannot be rescued in the same way as Greece, even if the political will were there. Therefore, the decision of S&P is also a declaration of mistrust of the European institutions as a whole, and the German government in particular. And here, too, the agency is illustrating the reality on the markets: Trust has long since been lost. Now time is running short to protect Italy and Spain from being infected with Greece's virus."

"In the meantime, it's become obvious that Greece cannot solve its problems without a debt haircut of almost 50 percent. In everyday language, that's called a state bankruptcy. Nevertheless, the bankruptcy chatter among politicians in Berlin is foolhardy. It is important to efficiently prepare for the debt forgiveness, so that the affected banks will have enough capital reserves, and to assure that European taxpayers won't be the only victims, but that the private creditors will also pay their share."

The center-right Frankfurter Allgemeine writes:

"Italian politicians are not up to the Herculean task of battling serious shortcomings with extensive reforms as the Greeks have done. Berlusconi lacks credibility, the largest opposition party is slipping further to the left, away from every austerity and reform program, and the center is offering only empty political rhetoric."

"No politician wants to admit that it is Italy's precarious situation that has transformed the crisis of smaller countries on Europe's periphery into a crisis for the entire Continent. Only warnings and alarm signals can help. Without external pressure, Italy will not make progress."

The Financial Times Deutschland writes:

"There are many reasons why the Italians should want another, better head of government. The question is whether or not it is a rating agency's job to determine that. They should refrain from mixing themselves into the domestic politics of a country."

"If one considers Italy's situation on purely economic terms, there is little reason for a new rating. Sure, the country's public debt, at 120 percent of GDP, is clearly too high, and the prospects for growth are dim. But that is nothing new. And Italy, unlike Greece, has produced a solid business model, with strong world-class businesses and banks that, thanks to little involvement in investment banking, were able to easily survive the crisis."

"Italy needs reform, both political and economic. But it doesn't take a downgrade by S&P to realize that. The ratings agency only hurts itself. It is opening itself up to accusations of wanting to become involved in politics. For a company that is being paid by its clients for its objectivity, this cannot be good for business."

The conservative daily Die Welt writes:

"Unlike Greece, Italy does not have a short-term liquidity problem. The Republic will be able to pay civil servants' salaries for more than the foreseeable future. But this country in the heart of Europe has a long-term debt problem, and one that could break apart the common currency."

"That is known, and was known to the ratings agencies. So why does the downgrading come now? Prime Minister Silvio Berlusconi gave the answer himself when he criticized the move as being politically motivated. It is, of course. Italy's biggest problem is the buffoon at the head of its government."

"National debt of 120 percent of annual economic performance, interest rates of 5 to 6 percent, and marginal economic growth, that is all good reason for worry that in the medium term, the country will be overwhelmed by its debt. Greece finally understood that the time had come when it was standing on the precipice. One would hope that Italy would not follow that lead."

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