Wednesday, May 10, 2006

A Valuable Lesson From Today's Market

Well, we spent a good amount of time early this week anticipating the Fed news and, when all was said and done, we ended up trading pretty much where we had been all along. But there's a lesson in all that.

A trader called me before the Fed came out with their statement and asked if I had an opinion about what the market was going to do. I gave the answer that I've mentioned quite a few times on my personal site: Keep an eye on interest rates and the dollar. If they don't sustain directional moves after the news, it means that the markets are not repricing assets as a result of the Fed statement. Under those conditions, stocks may jerk up and down, but are less likely to trend.

Conversely, if bonds/notes and the dollar make strong directional moves after the Fed news, I explained, it means that the markets are pricing in new valuations, because the Fed news is real news. That would be more likely to lead to stock index repricing as well.

As it turned out, the dollar was weak but could not sustain a trending move relative to the Euro, which traded first below, then above, and then below again its average price for the day. The 10 year interest rates spiked higher on the news, then stayed firmly in their multiday range. Not surprisingly, stocks closed near their average price from the previous day.

The lesson is this: There's nothing wrong with predictive models--including the kinds of predictive looks I take in this blog. Ultimately, however, it is more important to *identify* what markets are doing and *understand* why they might or might not be moving. The trader who saw the bigger picture was more likely to fade the overreactions to the Fed news than the trader than the trader who got caught in a directional opinion.

Oil, interest rates, currencies, other commodities, international markets: all compete for assets and all are inextricably interrelated in a world economy. Today offered a good lesson: The big picture matters--and sometimes nothing is happening in the big picture.