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SH @ the close 8/30/2011: When bad news is good

Today is was reported that consumer confidence plummeted to its worst levels since April 2009. On top of that, minutes from the latest Fed meeting showed that many in the central bank think the U.S. economy is growing fragile at best. While a report on housing today did show some signs of improvement, the housing market is still marred in a bottoming process. With all of this perceived bad news, one’s natural reaction would likely be to expect a sell-off, yet the market rallied. Why, you ask? Because bad news is good when the market is looking for a hand out.

As the economic data continues to suggest that the U.S. economy is in danger of sliding back into a recession, this only puts more pressure on the Fed to provide further stimulus measures. The market, as evidenced by the recent price action, is no doubt getting its hopes up for such stimulus. We reiterate that we are in no position to analyze the effectiveness of any stimulus the Fed may enact, but we are in a position to analyze how it might impact the markets.

When the markets get their hopes up, as they are doing now, the psychological effect can be dangerous for the bulls. Should the Fed introduce stimulus measures that fall short of the markets expectations all of the gains from this recent rally could be wiped out in a couple days time. Furthermore, what is the market even expected? It is impossible to tell. Could it be that the recent rally is all about the market “pricing in” a third round of stimulus from the Fed, and that when it is announced it will essentially be moot point? We certainly think so. Remember, the market is forward looking, if the markets gets a hint that something may be coming (good or bad), it immediately starts figuring out how it is going to impact the markets in the future, and it reflects those expectations in daily price action.

The clearest example of this is when a company issues their earnings guidance. If guidance is better than what analysts were thinking it would be, the market immediately starts to adjust by driving the companies stock price higher. It doesn’t matter that the earnings from the guidance haven’t been realized yet because the market is focused on what it thinks is going to happen. That’s why many times you will see a company report bad earnings but issue strong guidance and shares really anyway. Hmmmm… sound familiar? Kind of like how the market has gained back all of its losses from the S&P U.S. debt downgrade (remember the 600 point drop in the Dow that caused). It is because that has happened, and the market is now focused on what it thinks might happen in the future, in this case further stimulus from the fed.

In the mean time, drown out the noise and focus on the charts. For SPX to validate its recent bullish move to new highs we’d like to see it hold support in the 1,175-1,185 range as that area was prior resistance. The bears are likely to start coming out to play around current levels as SPX is now just below significant resistance in the 1,225 – 1,250 range. Buy dips that hold support, get short rallies that respect resistance… rinse, wash, repeat. Simple as that.

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