Bernanke Holds the Key For the Markets….Again.

by Dan August 4, 2011 8:14 am • Commentary

As I write this morning at 8:15am, the S&P futures are down about 1%, reversing much of yesterday’s rally off of the lows.  Wednesday’s action in our markets was encouraging when you consider how most of Europe got crushed into their session’s close and that throughout the morning’s weakness the VIX was actually down. This was a very curious situation and in many ways the answer could be quite simple; those that bought protection prior to, or at the beginning of this recent downdraft are starting to monetize those hedges, and thus selling out the options they own and depressing the near term VIX reading….Many who view the VIX as a fear gauge might have taken their cue from the index’s weakness yesterday morning when the market’s were down about 1% and seen that as a sort of all clear sign to buy them, that sellers of stocks were getting exhausted……I am not sure that really got you anywhere though as you wake up to this morning’s weakness.  Check back later for an update on my portfolio hedge from late May (here).

The DAX, after showing amazing relative strength throughout the first phase of the European Debt crisis quickly caught up to some of it’s lesser neighbors in the red for the year and is now down 4.5% after this weeks almost 10% swoon from Monday’s opening high.  The Index is now down for it’s 7th straight day in a row and quickly approaching the March low.  The health of Germany’s economy is becoming a question heard more often as many wonder how they can hang in with everything crumbling around them, and as many consider the prospect for the U.S. to enter another recession.

As we head into next weeks FOMC meeting all eyes and ears will be glued on the potential for a third round of quantitative easing as it appears that the recent slew of weak economic data has changed the fed chairman’s prerogatives since he last spoke just a couple of weeks ago……Tomorrow’s jobs data will likely be the nail in the coffin of the recovery and could be the precursor to any indication of the Fed’s future actions to be articulated at the annual Jackson Hole boondoggle later in the month.  Last year’s now infamous Jackson Hole speech by Bernanke which led to QE2 and a rally of epic proportion in the equity market’s will likely be a distant memory as the dire nature of any action this year will likely have a very different affect on risk assets in my opinion……this will not feel like a pinata with a never-ending candy supply this time around…..


Looking at the SPX performance last year could be instructive to how this year may end…..2010 saw a fairly volatile year with many peaks and troughs ending with a reverse head and shoulders bottom that lead to the massive break-out above the range that continued into this year.

2010 SPX chart from Bloomberg


The chart below (click on it, makes it much easier to see) shows the magnitude of the moves…..+/-7% ranges seemed liked the name of the game until we had the last move.

2010 SPX chart from Bloomberg


When you look at this year’s performance in the SPX you see a similar pattern where we have gyrated in a range between 1260 and 1360 until this week’s break below.  Will we see the opposite of last year where we are now making a head and shoulders top leading to a massive breakdown below the range?

2011 SPX chart from Bloomberg


Not to put to fine of point on this, but the next week’s events, and the markets reaction, could very well determine the direction of the markets for the balance of the year.

I remain in the camp of caution, but I do want to place some bets where I think there is a potential for reversion like GLD (here) and CMG (here).  As always I want to define my risk, and look for low premium cost affective ways to express these views while defining my risk…….YOU DO NOT WANT TO BE SHORT STOCKS LIKE GLD AND CMG IF THERE IS A TURN.

As we head into tomorrow’s employment data,  there are a couple ways I see this going…….if we rally into the number we run the risk of selling off on the news and if we get sloppy today it puts the risk to an upside move….I am hard pressed to see much improvement in the data tomorrow and at this point the market’s reaction will largely have to do with where we are starting from……This is important when you consider the markets propensity to move on QE3 rumors as was the cause for yesterday’s afternoon recovery…..shorts have to cover on that stuff……

As always, move your feet in markets like this….for traders don’t be afraid to take some profits when you have them and try to cut your losses quickly, even if that only means reducing your position.