Wednesday Review: GDP Pleases but the Fed Disappoints

As predicted, tod ay w

as a day filled with market moving news, and the market did not disappoint. The day started off with a shocking headline: Economy in U.S. Shrank at 6.1% Rate in First Quarter (Update1) – instead of the median consensus of a 4.7% drop. However an analysis of the detailed showed that the drop was due to inventory correction and lower government spending; two factors which will likely push the GDP up this quarter.

Further consumer spending increased at an annual rate of 2.2%, the highest level over

the past two years. After the initial knee-jerk sell-off at

the headline number, the futures rallied big and never looked back.

Small Caps Lead

Small cap stocks (IWM), a measure of risk appetite soared to the highest level of this rally.

They took out the prior highs well before the Fed news.

The other major indices also rallied but not to the same level as the Russell 2000.

The breadth of the market was very strong, and the NYSE Tick indicator did not register a -500 reading till 2:00PM!

Fed Disappoints on Quantitative Easing

The FOMC minutes did not have anything new to add to information about the economy or the Fed’s QE policy. Many market participants were expecting an increase in the QE efforts since treasury yields have been climbing steadily. As expected, treasuries sold off with the 30 year bond yield (TYX) jumping 10 basis points and the 10 year bond yield (TNX) jumping 8 basis points.

The dollar also jumped higher against other currencies.

Equities Sell-Off

As I had written last night, a rise in yields put a damper on equities. After some initial volatility, the equities reversed their day-long strength and sold off into the close.

Though most indices finished with strong gains, they closed well off their intra-day high.

However, the day was still very bullish since the major indices broke through key technical levels. The SPX crashed through the 875 level and traded as high as 882.06, very close to the 23.6% retracement of the 2007 highs and 2009 lows (881.38), before pulling back.

One sign of worry was that leading consumer driven stocks like Amazon and Research In Motion were under pressure all day long, in spite of the positive surprise in consumer spending reported in the GDP report.

It seems that some market participants do not expect the rise in consumer spending to sustain and were using the strength in stock market to distribute their holdings.

What Next?

The market clearly has a bullish bias, and there will be end of month window-dressing as fund managers pad their portfolios with better performing stocks.

The strength of market internals was impressive; however the S&P500 failed to close above the 875 level, and the S&P Futures are down a few points from the closing level.

I continue to be primarily in cash though I have added some calls (CTSH) to my portfolio. I was lucky enough to buy some calls on the TBT right before the Fed announcement, to hedge my TLT holdings. I have closed my TBT calls after the pop, and will be distributing my TLT holdings over the next few days. Though the bond yields have broken through key technical levels, I do expect some pullback going into the weekend as traders who were short book profits and the current high in risk appetite wanes a bit.

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