Stock Market Plea to the Fed: "I Say Doctor, Ain't There Nuttin I Can Do to Relieve This Belly Ache?"

The stock market has been violently ill for many a moon now. The upheaval in the economy has become so unpleasant that some have aptly nicknamed this "The Great Depression of 2008." It has a nice ring to it, and Rhyme's rather well.

Federal Reserve Acts as Witch Doctor or Medicine Man for US Economy
In recent months, if the Federal Reserve's measures to stabilize the economy and financial markets were converted to a Witch Doctor language, it would translate something like this: "You put the lime in the coconut, and drink them both up / Put the Lime in the Coconut and call me in the morning."

Merrill Lynch's analyst Daniel Tenegauzer response to all the recent Federal Reserve's interventions was that they were "not a panacea" but "more like an aspirin."

Goldman Sachs said yesterday, ``we are not convinced that yesterday's move will solve all the multiple challenges facing credit markets and the financial system.''

Citigroup said ``credit concerns are likely to persist and averting a drawn out recession is becoming increasingly challenging.''

I guess these sell side houses either do not believe in Witch Doctors or in the Fed acting as a Witch Doctor anymore. If you think about it, this is a huge concession to admit the Federal Reserve is not omnipotent. Moreover, it represents a huge paradigm shift in our belief system about the Federal Reserve. We no longer see the Federal Reserve as omnipotent and infallible. It is akin to the Death of God that evolved amongst and scholars during the Age of Reason. Okay, enough funning for the moment, it is time to get down to the brass knuckles of what their 28 day $200 billion of liquidity for the economy and for the financial markets, and in particular the stock market.

What does $200 Billion mean for the Economy and the Stock Market Near Term?
No one can say for sure what the 28 day injection for $200 billion will mean for the economy and stock market. Perhaps at best, it only delays the imminency of a very large and growing credit crisis that could well implode into a debt deflation scenario not unlike the 1930's Great Depression. But for now, we will leave that aside.

All we want to do is make an educated guess of what the impact of $200 billion dollars means for stock market for the next month perhaps. If we consult the charts, one very clear picture emerges. Namely, every Federal Reserve attempt to stabilize the credit markets with liquidity surprises since November has resulted in stock market bounce. So, investors should expect another bounce, but all the while bearing in mind, we remain in a bear market until proven otherwise. On balance, that means surprises for investors should be to the downside over the next several months.

Seemingly, there is a wall of positive inputs for the stock market to consider between now and the end of Q1 08. Next week, on Tuesday March 18, the Federal Reserve will cut rates 50 bps to 2.5%. On Monday, March 24, the Fed will auction $50 billion at the TAF. On Thursday March 27, the Fed will auction off $200 billion of treasuries at the new TSLF (term securities lending facility) window. All these Fed events to stabilize the credit markets should work to also work to keep the stock market range bound with an upside bias near term.

All told, the Fed is adding $300 Billion of liquidity to the primary banks to meet end of quarter funding needs. Somehow this is so much larger than the $48 billion 2007 year end funding the Fed provided in December through the TAF window. $300 billion is also legions more than the $3.6 billion required to heal the LTCM crisis and Russian Default in 1998. The scale and magnitude of this unprecedented short term injection of liquidity by the Federal Reserve also argues for a stable equity market going into the end of Q1 2008 and beginning of Q2 2008. Not unlike the Y2K liquidity injection by the Fed, if this liquidity is removed or the crisis grows even larger by mid to late April, equity investors will have a big problem on their hands. As I recall, the initial drop in the stock market after peaking 15% in 15 days. A downside dislocation in the stock market of that magnitude would not surprise in Q2 08 if the financial crisis worsens as it is expected to.

The SP 500 chart below shows an 11 day bounce off the surprise Nov 26 Fed announcement, and a 9 day bounce off the Jan 22-23 Fed Surprise of a 75 bps rate cut and bond insurer bailout. The third Fed surprise came this week, with the $200 billion TSLF announcement. At the least, this should at least keep the stock market range bound into the March 27 2008 TSLF auction or into early Q2 2008. But all bets are off if below the March 12 retail sales lows at 1282 and the March 10 TSLF low at 1272. A failure of 1272-1272 would signal the crisis is evolving in a very unpleasant way.

John Bougearel
SuccessfulTradingTips.com