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Saturday, August 25, 2007

The Bernanke Bounce

Lasts friday’s surprise discount rate cut resulted in exactly what Bernanke was hoping for. Those traders that were net short via options were annihilated on the first print where the options instantly expired. The whole process and the consequences are explained very well by Adam Warner from the Daily Options Report in the post The Bernanke Short Options Squeeze. The result was a week long, low volume, unenthusiastic short covering rally.

Bill Luby from VIX and More pointed out the strong mean reversion tendencies of volatility in his posts throughout the week. In the post VIX:VXN Ratio Extremes he demonstrates that the market new something wasn’t quite right with financials as early as February. In yesterday’s post I pointed out the double top and early negative divergence of XLF from broad market indexes as an early warning sign.

Tim Knight has long declared himself a Bear and has been posting fantastic short trades on The Slope of Hope. In the post The Voice of Reason (in a world gone mad) he presents a list of short candidates and argues each and every case for short entry in great detail.

Macro Man continues to present very thorough analysis of economic data. In A few thoughts on economics Macro Man argues that economic conditions and liquidity conditions are both weakening enough that markets will attempt to retest recent market lows established on Thursday. He further argues that this dip should be bought as massive quantities of liquidity held by brick countries and Sovereign Wealth Funds could swoop in and put a floor under prices.

Will Rahal argues for a ‘negative bias’ on Monday based on his proprietary and other indicators in the post Short Term Top for Monday August 27th. I have come to the same conclusion using different measures. This week lacked volume and therefore conviction. Short term oversold indicators have been relieved and prices are coming up on key resistance levels on most equity indexes. Also of significant interest is the fact that while general indices rallied such as the DOW, SP500 and NASDAQ, financial indices across the globe such as XLF and did not. Volatility is actually oversold now as well. Furthermore, I believe weekends over the next little while will bring a lot of headline risk. Its is far more likely that the causalities of the liquidity crunch and forced de-leveraging will be discovered and reported over a weekend rather than on any other day of the trading week.