10/13/2011 8:53:41 AM

Fed minutes spoil the bullish mood...

Recommendation:
Take no action at the open but watch for an update.

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

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

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Daily Trading Action

The major index ETFs gapped up at the open and continued to move higher into the afternoon. Shortly after the Fed minutes were released, the major indexes reversed course and headed lower into the close with a precipitous drop occurring in the final fifteen minutes. This left all three major indexes closing with fractional gains after having been up strongly before the release of the Fed minutes. The Dow Jones Transport Index (IYT 82.75 +1.07) finished with a gain of a bit more than one percent. The Russell-2000 (IWM 69.82 +0.98) closed with a gain of nearly 1.5% after having been up more than two percent intraday. The semiconductor Index (SOX 369.18 +3.48) added a fractional gain. The Bank Index (KBE 19.34 +0.59) added three percent and the Regional Bank Index (KRE 21.81 +0.56) tacked on a gain of similar size. The Finance Sector ETF (XLF 12.75 +0.32) added more than two percent. Long term bonds (TLT 114.49 -1.69) fell more than one percent but appears ready to bounce. It is in a trading state. The BIAS of all equity indexes we regularly monitor is BEARISH but all have warned of a potential move to a BULLISH BIAS. The BIAS of longer term bonds is BULLISH but has warned of a potential move to a BEARISH BIAS. NYSE volume came in below average with 1.065B shares traded. NASDAQ volume was also below average with 1.760B shares traded.

There was a single economic report released:

• The MBA Mortgage Index showed an increase of +1.3% last week

The report was released two and one half hours before the open. The real mover for the day was the release of the minutes from the Fed's last meeting. The minutes were released at 2:00pm EDT. The members of the Fed were uneasy about their expectations for gradual growth citing several "downside risks" including deleveraging of households, bigger than expected fiscal tightening, and potential spillover from Europe. Shortly after the minutes were released, the major indexes challenged their intraday highs and rolled over to head lower into the close. It appears that market participants turned more bearish after reading the minutes.

The U.S. dollar fell nearly two thirds of one percent but appears to have potentially bottomed as it closed just above its 200-DMA.

The yield for the 10-year note rose seven basis points to close at 2.23. The price of the near term futures contract for a barrel of crude oil fell twenty-four cents to close at $85.57.

Implied volatility for the S&P-500 (VIX 31.26 -1.60) fell nearly five percent. The implied volatility for the NASDAQ-100 (VXN 32.34 -1.76) fell just over five percent. Implied volatility closed at the low end of its range since early August. It is likely to bounce here before breaking out of its trading range.

Market internals were positive with advancers leading decliners nearly 4:1 on the NYSE and by nearly 3:1 on the NASDAQ. Up volume led down volume 5:1 on the NYSE and by more than 3:1 on the NASDAQ. The index put/call ratio fell -0.15 to close at 1.88. The equity put/call ratio fell -0.15 to close at 0.63.

Conclusion/Commentary

Wednesday saw a bit heavier trading volume and solid gains all around. Market internals were also strong. However, we also saw a number of signs that this advance may have to take a breather. The primary catalyst to worsening sentiment was the release of the Fed minutes which painted a worrisome picture where fed officials see any number of downside risks lurking. With that said, the market is already aware of these risks. The reaction, however, was clear and the heavy selling in the final fifteen minutes was disheartening (for the bulls).

We are now in earnings season and there will be daily posturing based on which companies, met, exceeded, or missed expectations. The large banks are in the line-up early on with JP Morgan Chase (JPM 33.20 +0.90) announcing before the open on Thursday. We aren't predicting any disasters. It would be normal that more than half the companies exceed analysts expectations. It is the guidance that can sink the market or cause it to become euphoric and it is something we will monitor.

The leading indexes (NASDAQ-100, Semiconductor Index, Russell-2000, and Dow Jones Transport Index) all added to gains but the NASDAQ-100 and Semiconductor Index both looked tired, adding only fractional gains. We don't have anything to mark a definitive top here, but there are enough warning signs that we are now nervous. We believe that the markets are likely to have topped on Wednesday and we are now looking for downside action. The question is, what will the downside look like and can we make a profitable short trade? For the open, we will maintain our long trades but we will monitor intraday trading action to consider entering a short trade at the close as we could be setting up for a gap down open on Friday.

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