With S&P 500 futures falling from 1.7 million contracts last Thursday to 1.5 million Friday -- and then back down to 1.2 million on Monday, the message is clear. As the Federal Reserve's two-day meeting starts, traders are cutting back and volumes are falling. We doubt very much that the Federal Reserve can raise interest rates. But that doesn’t mean the markets won’t rally. We have a term for this and it’s called ‘thin to win’.
Yesterday the S&P opened weaker but with only 250K in globex volume. It was clear that there was little conviction behind the selling and after the ESM made its early low, Europe closed, traders went to lunch and the algorithmic and HFT programs began to chop the market up and move it higher. We reminded me of just how difficult it is to short this market -- and until proven otherwise, the tape rests with the bulls who once again rebounded trying to test the 2100 area that we recently referred to as a 'magnet'. It’s why MrTopStep always says that “it takes days and weeks to take the S&P down but only a day to bring it back” as the equity markets have become well established. It can take hours for sellers to establish momentum, which can be easily dissolved in this market. Until proven otherwise, the adage remains true, “never short a quiet market”. And while we will see some selling over the next few months, we maintain that “thin to win” will remain in our favor.
Lost Opportunities And The FED
The ESM16 chopped around for most of Monday’s trade and then firmed up on the 2:45 cash close, trading from the 2075.00 area up to 2083.00, and then eventually up to 2091.25 on Globex before going back down to 2085.00 around 7:30 CT. While many traders we talk to think that the markets are getting ready to trade back down, we are not sure about that. Will the futures trade back above 2100.00 this week? We think they will and the Fed will help with the first part of the push when it declines to raise interest rates (and the BOJ later in the week will only help). Like many traders, I doubt the long-term prognosis for global stocks, but as long as ‘zero borrowing cost/zero interest rate’ exist, it’s going to be a hard-fought battle. According to John LaVorgna, chief U.S. economist at Deutsche Bank (DE:DBKGn), “They’re going slow because they missed their opportunity. The Fed could have raised more last year or at the recent March meeting.”
The Fed has backed themselves into a corner with double vision over the last year. Despite last August's volatility, members continued to maintain that economic conditions were ripe for a hike that ultimately took place in December. Shortly thereafter the equity markets began another corrective decline and economic indicators in the U.S. began to look very questionable. A few weeks ago Chair Yellen said that rates could again be lowered, or that more stimulus in the form of quantitative easing could be injected into the markets -- even as the S&P began to soar. It’s no secret that what helped stabilize the financial markets post 2007-09 credit crisis was the easy money that floated around adding a great deal of liquidity to the markets. When the Fed threatened to remove this last year, the indexes saw the first 10% decline in four years -- and once the Fed did begin to tighten policy, the equity markets declined. Then the Fed began to back off of from its the mid-year projections and the markets began to rise. See how this works? The move to all-time highs were not a result of inclining economic indicators post 2007-09 recession. The economy, while improving, remains stagnated. What the Fed gave to the financial markets was a drug similar to what it gave to the housing markets post 9-11.
As long as the Fed keeps monetary policy low, the markets will continue to rally. On Monday we learned that the Bank of Japan owns 10% of the Nikkei. The central bank has pulled out all the stops to combat economic decline since the 1990s in an effort to keep its financial markets at rest using negative interest rates to inject some economic stability -- which never seems to come. At the end of the day, the U.S. Federal Reserve faces a question of integrity. It has boxed itself into hiking rates, while history has shown that it's on the wrong side of the markets.
Our View
The S&P 500 may get even harder to sell over the next day and a half. We can’t rule out some type of a drop on Wednesday, but we also can't rule out a rally after the drop. One of the rules we trade by is to fade the first move after the fed’s decision -- and if the futures drop fast, we think they will recover even quicker. But that’s for Wednesday. And we still have Tuesday to deal with. We all know the first day of a two-day fed meeting can be slow. After all the reports and earnings are released, the S&P should go into a very slow grind.