Latest FOMC Meeting Disappoints Investors Once Again

Measured by the response of the SP500, we can see that the last two FOMC meetings on October 31st and December 11 have clearly disappointed investors.

While this reaction of the December 11 FOMC meeting has been short term bearish, the recent weakness did occur on overbought conditions. So the FOMC announcement was a convenient excuse for a retrenchment. Investors should be cognizant that the low set on November 26 following the Oct 31st FOMC meeting occurred on the Fed announcement that they would begin providing liquidity into year end for the money markets adversely affected by the credit crunch beginning November 28. With that initial injection, the SP500 gapped open 1% higher above the previous day’s 1426 settlement to 1441.

While the week ending December 14th ended on a sour note, and almost 4% below its December 11th high, investors should note that the settlement at 1468 on Friday December 14th was very near a cluster of supports beginning with the Q1 high at 1464-1465, the December 4th close gap at 1463, and additionally the 50% Half Mast Retrace to the November 26 low. And recalling from above, it was the week of November 26th, when the Fed 1st promised to ensure adequate liquidity to the credit markets through year end.

This half mast retrace to the November 26th liquidity promise low takes on added significance for the week beginning December 17 as we will see the Fed make good on their promise by injecting another $40 billion into the short term credit markets that need cash injections so badly. (Furthermore, the Fed has announced two more injections coming in January 08 and will make further cash injections as needed depending upon how “market conditions evolve" – but that is a story for later if need be.)

As ample liquidity is made available to the credit markets, the widening of the credit spreads in the LIBOR and US Commercial Paper markets we would expect to begin to narrow considerably thus easing the recently heightened pressures there. Of course that still remains to be seen, and will be something to watch closely in the coming week. Ideally, by the end of the coming week, the SP500 will have reached another oversold condition that will help mitigate downside risks that are present as we start the week out. Of course, evidence of a tangible narrowing of the credit spreads by the end of week will be the biggest boon to the market that investors can hope for in the near term.

In a very direct sense, we can say that for equity investors, these cash injections of providing "Liquidity on Demand" that began in late November have been acting as the bullish counterpoint to the recent bearish responses the SP500 has had to the last two FOMC announcements. Will, however, the injections coming this week be as favorably received as happened during the week of November 26 and in particular November 28?

Now, it must be said that 1463-1465 is only the upper tier of a broader support zone. It is quite possible if the week is predisposed to starting out horribly, the SP500 could easily test the November 28 cash injection low at 1441 and last years high at 1444 (1441-1444) or even worse. Things would become worrisome indeed if the market closed below the Nov 27 close gap at 1426 and last years close at 1428 (1426-1428), but of that we need not be too concerned as yet.

In final summation of a consideration that the SP500 may be close to setting a short term low with the week ending December 14th or the week of December 17th – for a seasonal low into the New Year is not uncommon around now. December 17 1996, December 19 1997 along with December 14 1998 and December 14 2001 all set short term lows for the stock market.

It should be noted that the liquidity on demand that the Fed and other central banks have been providing to the money markets over the past several months serves not only to just paper over the losses incurred by foolish risk-taking by financial institutions, but it simultaneously creates excesses of this liquidity which must spillover somewhere (see Marc Faber’s Tomorrow’s Gold).

In my mind, the best place to look for that spillover is into the sectors of the global economies that are still growing and have sustainable momentum, and into equities that have a sustainable higher earnings growth rates. Just about other place to invest may possibly be at some risk to subprime contagion or at risk of becoming a value trap. As Lowry’s Paul Desmond has noted, market breadth has been narrowing (no surprise there) in this bull market that began in 2002-2003, and the ratio of New High/New Lows has not been confirming the broad markets new peaks in October 2007. The Lowry indicators are flashing yellow warning signs that investors be extremely prudent in their stock selection criteria.

click to enlarge