Thursday, September 22, 2011

Re-Testing 1100

The stock market hasn’t responded very well to the Fed’s latest stimulus attempt, to put it mildly. In case you hadn’t heard, the Fed announced the widely anticipated “Operation Twist” yesterday. The program involves selling $400 billion of shorter-term Treasuries that are currently in their portfolio, and using the proceeds to buy longer-dated bonds. The idea behind it is similar to the last two quantitative easing programs -- the Fed is attempting to drive down longer-term interest rates even further than the record lows they were already at prior to the announcement, in an attempt to spur the economy. However, this latest attempt differs from the earlier ones in that they won’t be expanding the size of their balance sheet. They’re simply swapping shorter-dated securities for longer-dated securities.

The past two days’ rout on the heels of the Fed’s announcement has wiped out the 5% gain that occurred last week. As I write this Thursday afternoon, the S&P is trading at 1121. The closing low on August 8th was 1119, and the intraday low on August 9th was 1101. So despite several weeks of stocks bouncing around and holding above this low, a re-test of that low is upon us. Often times, a re-test can be a healthy development and serve as a launching pad for the next rally. The reason we aren’t optimistic that is going to happen this time is that several other markets we’re watching have already broken their August lows, including the Russell 2000 (small-caps), the Dow Transportation Index, the EAFE index (international stocks), emerging markets, China, etc. These are all clues that the S&P is likely to follow suit, perhaps in the very near future if the downside volatility of the past few days is any indication of what lies ahead.

Chart: S&P 500 Index with 200-day moving average