When we read the FOMC statement shortly after publication on Tuesday afternoon, the first thought that came to mind was 'damp squib'. We thought the market wouldn't like this mixture of admission (that the 'recovery' is sputtering badly) and somewhat halfhearted inflationary measures (committing to a time table for ZIRP). Initially the robots agreed with us and a wave of heavy selling ensued. Interestingly, gold continued its recent negative correlation with equities and shot right back to the overnight high in the $1770 region. This is actually new – that gold likes an FOMC statement the stock market hates and vice versa. Then something seemed to click ('what, free money for a minimum of another two years? Not so bad, is it?') and the robots proceeded to buy everything back. When we say 'robots' we are not referring to the handful of human beings who still contribute a little to daily trading volume, but the computer algorithms who contribute to the vast bulk of it. Their participation in trading these days is what constantly produces enormous price swings as well as incredibly skewed 'market internals', such as yesterday's 77:1 decline/advance ratio - apparently a 'first' in the past eight decades, and almost twice the hitherto worst ratio recorded during the 1987 crash. Yes, the market was evidently 'oversold'.
We should mention here what it actually means, per experience, when the market manages to advance by over 400 DJIA points in a single day. It doesn't mean anything good as it were. So far – since the March 2000 top in the Nasdaq – every single time the DJIA has risen by 400 points or more in a single day, the market has not long after made new lows below the low whence the rally sprang from. On every occasion but one – the 2010 summer correction, which was comparatively mild – did the market subsequently suffer a larger decline than the one preceding the 400+ points single day rally. Obviously, the sample size is quite small and there is no guarantee of a repeat performance. The fact remains however that bull market rallies are just not that fast and big.
The intraday action in the SPX on Tuesday – right after the FOMC release everybody apparently went 'What? No QE3? Sell everything!'. Half an hour later, everybody went 'Wait a minute…free money for two more years? Buy it all back!' – click for higher resolution.
Interestingly, the bond market appears to have concentrated on the 'the economy sucks' part of the FOMC statement. In a departure of its usual positive correlation with stocks, the yield on the ten year note continued to collapse with great gusto (making a reversal even more likely of course, but this is rather disquieting action nonetheless):
We thought it was close to a reversal, but the ten year note yield hasn't complied and instead has continued its collapse, falling even below what we thought was an obvious support level in Tuesday's trading – right back to the 2008 panic lows. The bond market evidently sees nothing good ahead. This makes Tuesday's rally in stocks even more dubious than it already is – click for higher resolution.
