Getting A Little Bit Stretched, But...

12/16/08 3:45 PM EST

As of: SPX 1045 HELP  ARCHIVE

Equities have responded well to the FOMC announcement, and so far we're seeing a pretty classic follow-through to the seasonal patterns we looked at yesterday and this morning.

The S&P 500 has jumped 3% or more on the day of a scheduled (or unscheduled) FOMC announcement only four other times since 1995 (10/15/98, 01/03/01, 04/18/01 and 03/18/08).  Equities pulled back over the next 1 - 4 days each time, then resumed a rally lasting from a few weeks to a few months.  During the post-Fed short-term pullback, in all of the instances the S&P held above the close prior to the FOMC day (868ish on the cash S&P 500 index in our current case).

The afternoon extension of the rally has pushed a few of the most sensitive indicators we watch near or into overbought territory, and the indices are now brushing up against possible resistance around last week's highs.  If we can't make it over that hump by tomorrow morning, and we continue to register some overbought readings, then I suspect the usual post-Fed letdown will kick in again, leading to a one- to three-day pullback that should be relatively modest.

Even so, the longer-term outlook of one to three months continues to look alright, given the market's behavior over the past three days and the data we discussed recently (here and here and here), so I'm willing to give the idea of a continued rally more room.

I have a few layers of possible support I'm watching in the S&P, now being 880, 865 and 850.  I expect the index to hold above the latter two at least on any short-term pullback, and would be concerned about the intermediate-term if the last level fails.  Barring that, I think we have room to work 10%-20% higher in the coming month(s).

All's Quiet On The Eastern (Coast) Front

12/16/08 9:05 AM EST

Good Tuesday morning...we begin the day with a bounce in the pre-market futures as traders position themselves ahead of the FOMC decision early this afternoon.  Volume should be fairly light and drop off precipitously heading into the New York lunch hour.

Yesterday we took a look at a couple of tendencies somewhat related to where we are seasonally.  In terms of FOMC meetings, December and the looming futures/options expiration, there was a pretty clear positive bias to these weeks historically.  Monday was consistently the weakest day, but now that's out of the way.

In a "By The Numbers" blurb yesterday, I noted that the market has rallied 6 out of 8 times when when the S&P 500 futures lost 1% or more the day before an FOMC decision.  The two losers' losses were made up within one trading day, so a negative reaction ahead of this economic event, like most others, had a mean-reversion quality in the very short-term.

We are seeing a modest gap up in the major indices earlier this morning.  That, too, has tended to lead to short-term gains on FOMC days.  Since 1995 when the Fed began to explicitly target the Fed Funds rate, there have been 10 times when the S&P 500 gapped up 0.5% or more on the day of a scheduled FOMC meeting.  Buying the open and holding 'til the close resulted in 9 winners out of the 10 attempts, with an average return of +0.6% (using the S&P 500 tracking fund, SPY).

As we've discussed many times, however, any positive post-Fed bias was short-term only.  By two trading days later, the S&P was up only 2 times, and showed an average return of -1.1%.  So, generally, we saw strength the day of the meeting, then a dip in the day(s) following.

Our short-term trading guides, and most other indicators on the site, are mixed and not giving much of a clue either way.  In the Indicators At Extremes, there are only 7 indicators showing bullish (for the market) readings and 5 that are bearish, which is the lowest number we've seen in awhile.  The choppy trading of the past two days in particular have not been amenable to generating emotional extremes, so there is little edge evident in any of them.

We left off last week with an upside reversal off of a large gap down open, as the indices followed through on their historical tendency to recover from dramatic openings like that.  In the process, the major indices held the support levels we'd been looking at for awhile, and combined with everything else we discussed this week, the outlook over the coming month(s) continues to look alright.  We had a vaguely similar scenario in October, which failed during early November, and that's a concern - but given the developments last Monday and Tuesday and the other positives that have been gathering, I'm willing to give the idea of an imminent intermediate-term rally another shot.

For the short-term, sans any extremes of note in our indicators, I'll be watching the reaction in Goldman Sachs (GS) after today's earnings announcement, as well as Best Buy (BBY).  If the former can move up after a disastrous quarter, and the former shows a possible revival of consumer discretionary spending, it should bode well for the market in general.

Then, of course, we have the FOMC announcement and traders will be watching for any hints of extraordinary steps being considered.  The futures market is pricing in a 64% chance of a cut of 25bps in the Fed Funds rate, and a 36% chance of a 50bps cut, but due to the recent government interventions, this data is less applicable than before.

I'm still watching the support levels we looked at last week (roughly 850 on the S&P and 1140-1150 on the NDX), and expect any re-visitation of those areas will lead to another bounce, given the seasonal tendencies discussed above.  815 and 1100, respectively, are far larger support areas, but if we fall that far I'd be surprised.