The current stock market is fit for Harvey Dent of the popular Batman comics. On certain days, positive fundamental data is cheered and on others it is booed. Harvey Dent was nicknamed Two-Face and it is precisely that reason why I am labeling it Harvey Dent’s Market. Two-Face based outcomes off a coin flip using a rigged coin (it had heads on both sides). He had the foresight of knowing what the outcome would be before the coin came to rest. Similarly, retail investors are often blind to the outcome of economic reports and trade activity. A look into the action from Friday and Monday shows my point fairly well.
Good News is Good
Chicago PMI came in much higher than expected which lifted the S&P 500 marginally. Incoming tangent! Bear with me for a minute here. There is no unfair advantage or information leakage in the markets, right? Think again. High frequency traders (“HFT”) and institutions gain early access to certain economic reports and have the ability to trade on the information with incredible speed. Premium subscribers can see the PMI release at 9:42 ET while the rest of the world has to wait until 9:45 ET. Take a look at the below video, courtesy of Nanex, which depicts the first 100 milliseconds of trading after the early release. It is truly mind boggling.
Good News is Bad (or maybe it does not matter)
I think everyone forgot what month it was until the afternoon session. Equities sold off hard into close, marking a late revival in the “Sell in May and Go Away” motto. Maybe a great Chicago PMI number is not good? Maybe it was end of month selling or the realization of how terrible the ISM-Milwaukee number was in the face of Chicago PMI or the perception the PMI release may push the Fed towards reigning in its bond purchases. Either way, any good news was swept aside and replaced with shouts of “Sell! Sell! Sell!” a la Jim Cramer.
Bad News is Bad
After the release of the ISM Manufacturing report, we saw S&P 500 futures trade down to session lows as bad news was seen as bad. Both indices fell well under expectations and into contraction territory.
Speaking of information leakage, it appears the ISM release either leaked early or someone flipped a coin just prior to the release (See the following link for more details from Nanex on how trades began 15 milliseconds before the official release time: http://www.nanex.net/aqck2/4306.html)
Bad News is Good
You could almost see the wheels turning a few minutes after the release. “ISM Manufacturing prints at the worst level since the summer of 2009? Sounds bad which means the economy is not doing so well which means the Fed has to continue QE3!” Anything which can be spun to keep the QE-addicted market pumped full of liquidity will be and has been.
Bad News is Bad
It did not take long before people started to remember what Bernanke said recently about reducing or stopping bond purchases. Suddenly, bad news becomes bad again. If the Fed takes off the training wheels and the economy is still struggling, there will be pain in the markets.
Wait…maybe Bad News is Good!
The short sellers had a short selling window (no pun intended) because before long, traders remembered Chicago PMI printed at 58.7 on Friday and bad ISM means QE stays! Ever see the new Wheat Thins commercials featuring the tag line “Must have Wheat Thins?” If equities had a commercial on Monday, the tag line might have been “Must trade higher!”
You might be asking yourself what all of my rambling means for you. Quite simply, it boils down to the fact the economy is stuck in first gear and the Federal Reserve has created a situation where it is forced to sit on the fence. The risk-to-reward ratio of staying long in the market has tilted to the side of more risk than reward. We are participants in a sentiment focused market. Every whisper from Merkel, Abe, Draghi, Bernanke, etc. could mean riches or doom for your portfolio. In this environment, tactical strategists drool over the uncertainty because it is in these periods where we tend to shine. The flexibility of a tactical portfolio allows us to maneuver away from risk and into favorable opportunities.
Will the S&P 500 close higher or lower than today’s level at the end of the year? Flip Harvey Dent’s coin. I call heads. The detachment of fundamentals from stock market movement makes the forecast difficult. As I stated in my last post below, the Federal Reserve faces the challenge of deciding when to end its current accommodative policy. If the chatter becomes action, watch out! We will be in for a wild ride either way.
– Brian Durbin