Wednesday Roundup: FOMC Minutes Cast a Shadow on Green Shoots

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 |  Includes: BAC, DIA, GDX, IYR, MOO, SPY, TLT, TSO, USO, XLB, XLE, XLF
by: Vikram Saxena

The equity markets finished the day yesterday with small losses after a roller-coaster ride. As I had alluded to yesterday, I expected another day without a large change in closing prices. Though I did not bargain for a big gap-up followed by a major sell-off, the lack of conviction among both the bulls and bears was very visible.

Pump and Dump

The S&P 500 gapped up at the open, above the 916 level it had a hard time getting over yesterday. This led to more buying as the markets rallied well above the R2 pivot level, without a pause.

The rally was driven by financials with the bulls cheering Bank of America’s (NYSE:BAC) successful equity issue, and the energy sector which was anticipating a large draw-down in oil and distillate inventory.

The market internals were lopsided on the bullish side on both the Nasdaq and the NYSE, indicating a true trend up day.The US dollar was down significantly against most currencies helping the equities rally.

However, at around 10:25AM, five minutes before the release of the oil inventory report, traders started taking profit. I had alluded to this in a post on twitter earlier in the day. The oil report did not disappoint but the market continued to move lower. What was surprising was that the market continued to sell-off through the R1 pivot level, all the way down to the daily pivot level.

FOMC Minutes Show the True Economic Picture

Over the past few weeks, I have been alluding to the fact that the sentiment in the market seems to be manufactured. The Fed statement at the conclusion of the Fed meeting did not have any mention of quantitative easing. This was interpreted by the bulls as a message that the economy was better than expected sending long bond yields high, and cheering the equity markets.

However the FOMC meeting minutes showed that some member of the Fed are considering increasing the amount of debt the Fed will purchase from the market to support asset prices. The Fed members reduced their projections for economic growth in their quarterly forecasts, though they saw a slowdown in the rate of contraction; the second derivative as the financial press calls is.

It seems the ambiguity in the Fed message after the meeting was deliberately designed to improve sentiment to allow banks to raise capital after the Stress Test results. The FOMC minutes seem to convey a different message than what the market interpreted from the policy statement released after the meeting.

The equity markets added to their losses after the FOMC minutes were released with the SPX trading below the R1 pivot level before finding support near 900. The equity indices finished close to the low of the day, though the net change in closing prices was less than 1% across the board.

My Portfolio

The bipolar nature of the market has precluded me from adding any long or short positions. I continued to trade intra-day using set-ups I often share on twitter.

I added some puts on the IYR during the early morning rally, and continue to hold my TSO position. Bond prices rallied after FOMC minutes and I will be looking to exit the last lot of my TLT position on any continued strength.

Thursday’s Outlook: Lack of Conviction Likely to Continue

Since we are heading in to the Memorial Day weekend, trading volume is likely to decline, and the market is unlikely to make any sustainable move either way. Based on the nature of the U-Turn today, I expect a bearish bias. It is very rare for the SPX to breach the R2 pivot level but then reverse and go back to breach the S1 pivot level.

It seems the SPX has now found a new trading range between 875 and 930, and will churn in between. We seem to be in a mean-reversion environment, with no broad-based strength or weakness. As long as Washington DC continues to be the financial capital of the US expect this treacherous market to continue. We will continue to see vicious sector rotations. The better performing energy, agriculture, materials, and the gold sectors seem to be next in line for profit-taking within a week or two.

Even if the SPX is able to break out of the trading range, it is not clear whether that new trend will sustain. Neither the bulls nor the bears have the conviction to hold on to positions for too long. One approach is to buy options to trade the move out of this range; i.e. if SPX breaks 930 buy calls and if it falls below 875 buy puts. This limits the risk you take in case the move reverses, as it has happened so often in this market.