December 10, 2007

With the Fed meeting tomorrow and announcing their decision at 2:15 we are certain to see an extreme price reaction across the board once the decision is made. Tomorrow is the kind of day you want to have stop losses in place, in case the price action goes against your holdings. The best place to find out the Fed’s decision is by going to the Federal Reserve website. They post the statement immediately and make it available to everyone to read. However, the last couple of FOMC statements have brought a lot of traffic to the site, nearly grinding it to a halt.

Today’s rise in the market was unusual for the day before an FOMC meeting, as it is usually quiet and in waiting. Not so today, as investors gobbled up anything they could get their hands on in anticipation of a possible 50 point cut from the Fed. The last cut was only a 25 point cut and the one before that was 50 points. Stocks have already priced in a 25 point cut, and optimism continues to grow that the Fed will even cut it by 50 basis points. However, these hopes are unfounded, even though it is not impossible that it could come to fruition. Over the past couple of weeks the fed has definitely made an orchestrated effort to sell to the public of its willingness to cut rates further, but they never gave any inkling of an idea as to how much.

The breakdown of what to expect at 2:15 is as follows: if the Fed cuts 50 points the market will rally and will do so very strongly. Likely 2% – 3% gain in the market with less attention be given to the actual FOMC Statement. If the Fed cuts by 25 basis points, the action of the market will largely be dictated by the FOMC Statement itself and its willingness to continue future rates cuts. The default in this scenario would be for the markets to sell off. Finally, if the market does not cut rates at all, then without a doubt the market will sell off and sell off hard at least 2% – 3% with little consideration of what is actually stated in the FOMC Statement.

The likelihood is that the market cuts rates by 25 basis points and in its statement uses language to the extent that “future policy will be determined by economic conditions as they develop” with a reference to the mortgage markets and the need to contain inflation. Assuming we are correct, we expect that the markets will sell off at least 1% tomorrow.

Let’s review the charts…

NASDAQ finished strong today on declining volume, and could be setting up for a sell-off tomorrow ahead of the Fed meeting if the rate cut is not 50 basis points.

S&P fared well also but barring a strong rally on the FOMC announcement tomorrow, there is a bearish divergence in the S&P where the index continues to increase in volume, but is doing so on weaker and weaker volume. This makes us weary of the bulls being able to sustain recent gains.

All bets are off though, if the Fed cuts by 50 basis points (even though we don’t expect this to happen).