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Market Observations: 1998 -- Fed Moves, HILO, and BPNYSE

This past week has been wrought with volatility and worrisome headline news regarding the "Credit Crunch". This has resulted in plenty of banter and analysis with respect to the equity markets, and comparisons to past markets. One reference that keeps popping up, even in my own mind, is 1998. Recall this was a time of foreign currency collapses, the continuation of the "Asian flu", and then the subsequent collapse and bailout of the Nobel-prize laden Long Term Capital hedge fund. In other words, the pressure the equity market was feeling in 1998 came from a psuedo-exogenous event(s), not specifically germane to the equity market itself, but to an part of the financial market machine. Ultimately, the Fed had to step in -- to bail out LTCM, and in general stem the bleeding and bring stability back to the equity market. Kind of similar to now, in my opinion, but this time it is a liquidity issue caused by the subprime credit debacle. You may argue that this time is different, or may have the opinion that it is nothing like 1998; even still, we thought it would be useful to look back to 1998 to see how the market behaved, given that the Fed stepped in once again (on Friday) to offer liquidity to the floundering financial markets, answering the calls by many for lower rates.

Back in 1998, the behavior of the Fed was different than what we experienced just on Friday, but time will tell as to whether the Fed gets more aggressive with respect to rate cuts. More specifically, in 1998 (as the table below shows) the Fed administered three rate cuts of the Fed Funds rate, starting on September 29th at their scheduled FOMC meeting. It was the middle cut of 25 bps on October 15th that was the "emergency move". Fast-forward to today. On Friday the Fed stepped in, although in a more modest fashion, cutting the Discount Rate by 50bps. This was an action directed more at the liquidity or availability of cash, rather than the price of cash, and is more of a short-term fix. Nonetheless, this surprise move signaled a change in posture, at least to some degree, and offered a psychological and absolute boost the equity market. Whether or not the Fed will act further by lowering the more important policy tool -- Fed Funds rate, remains to be seen. The next scheduled FOMC meeting is September 18th.

That said, let's look at how the market behaved in September-October 1998 when the Fed acted to shore up the financial markets. In looking at this time period, we specifically turn our attention to the NYSE High-Low Index [HILO] and the NYSE Bullish Percent [BPNYSE]. As you can see in the table below, as well as the following charts, the BPNYSE actually reversed up before the HILO, in both the September and October reversals to the upside; and each indicator showed a higher bottom in October. What is also noteworthy is that the BPNYSE reversed up on the exact same day as the emergency Fed rate cut (October 15th), while it took the HILO another five days to do so. Whether or not it plays out this way again, we will act accordingly once these indicators do reverse up. In looking at Friday's market action, it does not appear that we will have a high enough daily reading to cause an upside reversal in the High-Low Index. Preliminarily, the NYSE Bullish Percent posted a very respectable performance, gaining roughly 5.1%. This would place the BPNYSE around 33.65%, where a reading of 36% is needed to reverse to X's and summon the offensive team back onto the field. We will, of course, continue to monitor the situation very closely and will alert you to any key changes in our market indicators.

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