How The Market Might React To The Fed

With the market stuck in a downtrend many participants are saying “Help me Obi Ben Bernanke. You’re my only hope.” Bear Stearns managed to wipe away any chance of a pre-Fed meeting rally. Rallies leading up to Fed meetings are fairly common as investors hope for good news. Selloffs prior to meetings are not common.

Over the last two days the S&P 500 has dropped over 2.75%. I looked back to 1982 to find other times where the market has dropped at least 2.75% in the two days leading up to a Fed meeting. I found six other occurrences. They were 11/16/82, 7/8/86, 3/30/87, 8/19/91, 1/29/02 and 5/6/02. In 5 of 6 cases the market rallied on the day of the meeting. The Fed generally managed not to make things worse. The average gain the day of the Fed meeting was 1.0%. The lone loss was only 0.3%. Looking out 2 days all six were positive and the average gain was 2.3%.

So if we get the “average” 1% gain tomorrow, then what? Unfortunately, Fed-day rallies have a tendency to be short-lived. Again looking back to 1982 I looked at buying at the close of any day there was a Fed meeting and the market finished up 1% or more. As you can see by the table below, after two days there is a negative expected value. Going out two weeks it generally gets progressively worse.

The market is oversold on a price basis. The VIX is spiking. The Put/Call ratios continue to put up overly bearish readings, and the Fed is meeting tomorrow. All these things suggest a bounce. Unfortunately, the last two days look rather ordinary on a chart. There was no washout or accelerated move lower. This calls into doubt the possibility that today could serve as a bottom should the Fed along with the positives mentioned above spark a rally over the next day or two. Right now a reasonable roadmap to keep in mind might be a short, oversold bounce followed by another leg lower. I’ll continue to re-evaluate as the next few days unfold, though.

P.S. While some readers may prefer a shot of Princess Leia in the golden bikini to the picture posted above, gold closing over $1,000/oz today meant I simply couldn’t afford it.