Matt Trivisonno’s Blog

Many traders believe that the bottom is in on the stock market because the Federal Reserve Bank kinda, sorta, might-be, hinting at a pause. Everybody knows that when the all-seeing Fed stops cutting rates, that the recession is over, right?

Well, maybe not this time. The chart below shows that the Fed has gotten way out in front of the market this time around. Chairman “Chainsaw” Bernanke has cut rates almost twice as fast as Alan Greenspan did during the last recession.

That could be a good thing, but it might be a bad thing too. How? Well obviously it indicates sheer terror on the part of the Fed due to the financial panic we all know about. And that terror is not over yet.

If the banking panic were over,

1. Bernanke wouldn’t still be trying to beat down the Libor rate which has vetoed his attempt to reduce rates on mortgages.
2. You wouldn’t see a long line of banks, hat-in-hand, bumming cash off of Bernanke at the discount window.
3. You wouldn’t see Bernanke swapping out perfectly good treasuries for crappy mortgage paper just so banks could pretend that they were still solvent.

Perhaps the bottom would be in if the Fed’s rate cuts really were helping the economy. But they are not. By the Fed’s own survey of bank managers, credit is still tightening. So far as anybody can tell, the rate cuts have done almost nothing.

Credit spreads have tightened from panic levels showing that the financial system is not breaking down. However, that is not really big news. One thing that we have learned over the years is that the global financial system bends, but it doesn’t break.

Yes, the Fed’s rate-cuts are well known to work with a lag. But the lag varies, and this time it will be a long lag. Why? Because the banks are simply destroying assets faster than the Fed can pump them up.

Credit is tightening. The economy is contracting. It ain’t over.

Note: The red dots on the chart show the fed-funds interest rate. The first “line in the sand” that Greenspan drew at 1.75% failed. The market just plunged right through it, and the next one at 1.25%. Even if Bernanke draws a line-in-the-sand here at 2% doesn’t mean that it will stick. Greenspan didn’t take his foot off the gas until he was certain that the economy was adding jobs. Bernanke won’t either. Rate hikes in 2008? Dream on…

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In the fourth quarter of 2007, the paychecks of American workers were growing at a rate of almost 9%. Here in the second quarter of 2008, they are not growing at all. That is a breathtaking deceleration of the economy.

Perhaps the global economy will save the US economy. But if that were the case, why are American paychecks being vaporized at such a rapid rate?

I, for one, will not get caught up in this bear-market rally. If you have long-side profits, you should think hard about taking them here.

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Today, the Treasury Department reported that withholding income tax revenue for yesterday was a paltry $1.46 billion. This was the lowest amount since June 13, 2006 when the number was $1.34 billion according to my database.

I wouldn’t read too much into such a data point since it is possible that it was the result of a data-processing delay, or some other glitch. However, I think the trend in withholdings shows that we should expect more such ultra-low numbers to be popping up in the future.

The jobs reports have been defying the downtrend in withholdings (and the plunge in corporate income tax revenue) but I doubt that can last much longer.

The market feels a bit “crashy” here, and a bad unemployment claims number tomorrow could trigger a bull stampede downward.

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Today’s gap-up open on the S&P 500 is what I am calling a “euphoric failure” because the morning’s euphoria was much weaker than the last two such events. I have marked the last three gap-up openings “A”, “B”, and “C” on the SPY chart below:

Click for larger chart

After Gap A, the market was able to hold onto most of the gains with little trouble.

After Gap B, the market held onto less of its gains after a struggle.

After Gap C today, the market lost ground. Also notice that today’s gap was much smaller despite coming off of a very strong reversal.

I interpret this trend as a thinning-out of the enthusiastic crowd of buyers who think that the recession is already over. Or you might say that the market is running out of baby seals to club.

Also notice how strongly the market sprang off of the lower trend line (purple) the first time it hit it back in April. This time, the snap-back is much weaker so far, and returning to the top of the trend line looks impossible.

The rally is weakening as it runs out of believers.

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Was today’s straight-up move a big short squeeze? Maybe. The news was all bad except for a blip down in oil, and volume was very weak, so there was no real catalyst. And we had a massive outbreak in bearishness as shown by the Birinyi and TheStreet.com polls that came out today.

So, everybody turned bearish at the end of last week, and did a good deal of shorting Friday. That left things ripe for a short squeeze today. However, today’s panic buying has left the market in a very over-bought state by some measures. If we get a gap up tomorrow morning, I will be looking to add to my short positions using the April 18th and May 2nd gaps as models. That would indicate that all those bears have turned into bulls again.

Jim Cramer thinks today was a set-up to a positive end to options week, but I don’t get that. If I were a gorilla big enough to move the market, I would have engineered today’s short squeeze so that I could load up on cheap puts, and then do my best to push the market down by Friday.

Update: Now that I think about it some more, perhaps FedEx was the catalyst today. The company disappointed, but the stock closed up. That indicates that shorts were taking profits on the sharp decline over the several days prior to the earnings report. Maybe the market had been plunging in anticipation of a “Recession is Worse” message from FedEx. Shorts who bought the rumor and sold the news could have done so for other sectors also. I smell a dead-cat bounce…

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