11/4/2010 9:03:51 AM

The Fed announced no change in interest rates and announced another round of quantitative easing but is it already priced into the market?

Recommendation:
Buy shares of DIA to close the short position at a limit of $112.30.
Buy shares of QQQQ to close the short position at a limit of $53.02.
Buy shares of SPY to close the short position at a limit of $119.95.

Daily Trend Indications:

- Positions indicated as Green are Long positions and those indicated as Red are short positions.

- The State of the Market is used to determine how you should trade. A trending market can ignore support and resistance levels and maintain its direction longer than most traders think it will.

- The BIAS is used to determine how aggressive or defensive you should be with a position. If the BIAS is Bullish but the market is in a Trading state, you might enter a short trade to take advantage of a reversal off of resistance. The BIAS tells you to exit that trade on "weaker" signals than you might otherwise trade on as the market is predisposed to move in the direction of BIAS.

- At Risk is generally neutral represented by "-". When it is "Bullish" or "Bearish" it warns of a potential change in the BIAS.

- The Moving Averages are noted as they are important signposts used by the Chartists community in determining the relative health of the markets.

Current ETF positions are:
Short DIA at $108.57
Short QQQQ at $49.66
Short SPY at $114.82

Daily Trading Action

The major index ETFs opened modestly higher and traded down at the open but within fifteen minutes they reversed course and headed higher for the next half hour or so when they moved sideways for some minutes before rolling over to start a descent that would last until the release of the Fed statement at 2:15pm. The major indexes then immediately bounced but headed lower within minutes in a move that would last until shortly after 2:30pm. From that point on, the major indexes headed higher. With forty-five minutes left, the major indexes faltered and began to fall again but the final fifteen minutes saw them make up that lost ground with the close near the high for the day. The Semiconductor Index (SOX 377.81 +3.62) gained nearly one percent. The semiconductor seems to be out in front with it and the NASDAQ-100 in uptrend states. The Russell-2000 (IWM 71.55 +0.28) finished fractionally higher but was lower most of the day as market participants were leery of the risk trade. The bank indexes closed higher with the Bank Index (KBE 22.85 +0.42) gained nearly two percent and the Regional Bank Index (KRE 22.81 +0.50) posting an even better return but both remain in downtrend states. The 20+ Yr Bonds (TLT 98.92 -2.06) gained one percent intraday but dove three percent lower by the close as the Fed announcement threatened the value of long-term (20+ year) bonds. NYSE volume was average with 1.1B shares traded. NASDAQ volume was just below average with 2.003B shares traded.

In addition to the weekly crude oil inventory report, there were six economic reports of interest released:

• MBA Mortgage Applications (10/29) fell -5.0% versus the prior months -3.2%
• Challenger Job Cuts (Oct) fell -31.8% versus the prior months -44.1%
• ADP Employment Change (Oct) rose +43K versus an expected +23K
• ISM Services (Oct) came in at 54.3 versus an expected 53.4
• Factory Orders (Sep) rose +2.1% versus an expected -1.7%
• FOMC Rate Decision (Nov 3) left rates unchanged targeting 0.0% to 0.25% Fed Funds rate

The first three reports were released more than an hour before the open. The next two were released a half hour after the open and while good, weren't enough to sustain bullish momentum as market participants awaited the released of the FOMC rate decision at 2:15pm Eastern.

Market participants were greeted with no change un the Fed funds rate and also by an announcement on quantitative easing. The announcement of further quantitative easing was expected and the specifics were somewhat in-line with expectations. The Fed announced that an additional $600B would be committed to purchase "long-term" bonds averaging 5-6 years at $75B monthly and they would also use about $35B monthly as other securities they bought matured. The market was expecting $500B to $1T in quantitative easing at around $100B monthly so this roughly fit expectations perhaps coming in on the lower end of expectations.

The dollar dropped like a rock closing at a new low just below the mid-October low. It is clear the Fed intends to continue buying bonds to try to stimulate jobs growth and inflation. The currency wars continue with the U.S. determined to become more competitive in a global marketplace by devaluing the currency. This isn't good for bond holders who will be repaid in dollars worth less than when they bought the instruments. The idea is to create a wealth effect where when people look at the value of their homes or stock holdings, if those assets are rising in price, people will feel more comfortable spending. Of course, this almost certainly creates asset bubbles, such as were just burst in the housing and stock markets and from which we are still recovering. For now though, equities look like a better investment vehicle than bonds.

Eight out ofl ten sectors in the S&P-500 moved higher led by Financials (+1.0%). Utilities (-0.3%) and Materials (-0.3%) were the only sectors to move lower.

Implied volatility for the S&P-500 (VIX 19.56 -2.01) fell nine percent while the implied volatility for the NASDAQ-100 (VXN 20.41 -2.47) fell nearly eleven percent. This suggests that market makers believe that the market will be less volatile going forward.

The yield for the 10-year note fell two basis points to close at 2.57. The price of the near term futures contract for a barrel of crude oil rose seventy-nine cents to close at $84.69. The weekly U.S. government report showed crude oil inventories rose by 1.95M barrels.

Market internals were positive with advancers leading decliners 7:5 on the NYSE and by nearly 4:3 on the NASDAQ. Up volume led down volume by 3:2 on both the NYSE and the NASDAQ. The index put/call ratio rose 0.37 to close at 1.52. The equity put/call ratio was nearly unchanged falling 0.01 to close at 0.55.

Commentary:

Wednesday's trading action was all about the Fed's actions and the falling U.S. dollar. While other central banks could pursue similar quantitative easing actions (in fact Japan has been intervening to try to devalue the Yen), the European countries have embarked on austerity programs and their central banks are unlikely to pursue these policies to a significant extent. This means that the U.S. dollar will continue to be devalued versus Asian and European currencies which will make U.S. goods more attractive in a global marketplace but will make imported products more expensive so should cause noticeable inflation to U.S. consumers and businesses. Likewise, U.S. dollar denominated commodities should continue to climb in price as will equities. That is, until they don't. At some point, fear takes over as dominant over greed.

Market participants understand that the rise in assets prices will eventually reverse and all of them believe they can get out of their positions before their peers. This is inevitable and is a primary reason that we have asset bubbles that eventually burst causing a new cycle of crisis. This is the reason for the collapse of thousands of hedge funds from the last financial crisis. Even so, many more hedge funds have risen to take their places. I am confident that the next series of asset bubbles bursting will results in fundamental changes in our financial markets and hopefully in the fiscal policies of this country. We have been fiscally irresponsible and this will eventually change, hopefully before the United States loses its place as a great nation.

The market itself has been making an advance with a BULLISH BIAS in place since mid-September. We ignored this fact and our positions are currently underwater because of it. We are of the opinion that this advance could last into or through January of next year so it is now a matter of how to exit our positions with the smallest losses possible. The major indexes will gap higher at the open and there may be a "counter-Fed" trade where price moves in the opposite direction from that on the day the Fed releases their interest rate decisions/statement. We are looking to exit our short positions at the closing prices on Wednesday and will place limit orders in place. We would then be looking to enter long positions at slightly better prices.

We hope you have enjoyed this edition of the McMillan portfolio. You may send comments to mark@stockbarometer.com.