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Help from the Federal Reserve

In spite of this, there have been some rays of hope this year, but not many. One example of this took place on Tuesday, March 11th.  This is when the S+P 500 futures rallied the most in five years, which trimmed its decline for the year to only 10%. What inspired this rally was news that the Federal Reserve was infusing an additional $200 billion into the banking system in attempt to restore confidence in banks that have been hurt by mortgage related write downs. The Federal Reserve said they will lend Treasury securities to troubled banks in exchange for mortgage backed securities that have lost much of their value. A good portion of this distressed paper is directly due to homeowner mortgage payment defaults. By lending Treasuries in exchange for mortgage backed securities, the Federal Reserve will let banks exchange debt that is less liquid and less desirable for Treasury paper. Within the plan, the Federal Reserve will lend Treasury securities for 28 day periods to at least 20 institutions. On the condition of anonymity, a Fed official said the program could be expanded as needed. This plan was announced after it had become more obvious that other measures they had taken to limit the impact of the credit crisis had failed to have the intended result. Losses at financial firms have been substantial and there are probably more to be revealed in the months ahead. Currently, there are rumors that a major commercial bank is on the verge of bankruptcy. Some traders are saying the Fed's rescue plan may have been a pre-emptive strike to alleviate a possible bankruptcy announcement.

The initial bullish response to this news was impressive, but it remains to be seen if the gains can be held.

Technical and Fundamental Indicators

Current technical and fundamental analysis suggests, in the weeks ahead, stock index futures prices will work lower. My technical analysis places a lot of weight on how stock index futures respond to various types of news. This brings us to one indicator that I have found to be very accurate for all markets and especially for stock index futures. This is the "opposite reaction to news" indicator. This signal may be a bit more subjective and less scientific than some indicators, but it works very well for short-term analysis and often when markets are making major highs or lows. The best example of this signal is when the news is all bearish or bearish on balance and futures are able to trade higher. This is a sign that some bullish factors are present, but not yet apparent. For example, the fundamentals: 1) may be changing for the better or; 2) possibly one or more large traders may be overextended on the wrong side or; 3) possibly there is little for sale above the market. Either way, it is a bullish indicator when futures perform better than the news would suggest. The bearish application of this indicator was evident during much of the recent decline in stock index futures as price trends showed a tendency to ignore bullish news of any kind, whether it was in the form of lowered interest rates, bullish economic reports or an improved international situation. So far this year, as was the case late last year, bullish news has not been able to support stock index futures for very long, if at all. In addition, bearish news tended to produce an over reaction on the downside. There appears to be no good reason to think that these bearish signals are likely to change any time soon.

Another technical indicator of great importance is how well futures follow through when chart buy or sell signals are generated. When chart buy signals do not follow through and sell signals tend to work well, we can conclude further price weakness may be in store for any given market. This is the situation that we are seeing now. One more often over looked short term leading indicator of the likely direction of stock index futures is the level of the U.S. dollar, especially against the Japanese Yen and the Eurocurrency. History has shown that the U.S. dollar has a tendency to be a leading indicator of a change in direction of other financial markets, including stock index futures. As long as these major currencies remain firm against the U.S. dollar, we can expect further selling pressure to come into stock index futures.

One of the best of the longer term indicators remains bearish as well, and that is the yield curve indicator. The current yield curve inversion is an extremely reliable signal that an economic recovery may be a long way off. The yield curve does not turn positive, which would be bullish for the economy, until September of this year.

Where are futures headed from here?

Currently, we can expect the shock of the Federal Reserve's rescue plan to soon wear off, as traders take a second look at its ramifications and place more emphasis on the inflationary aspects of more money injected into the banking system. Most likely, the plan will only have a temporary bullish impact on stock index futures. Lower prices for stock index futures are likely in the weeks ahead as the impact of the Fed's plan fades. In addition, the longer term fundamental influences are likely to stay with us, taking the S+P 500, Dow Jones and NASDAQ futures lower though the summer months and into the early fall period.

There is a bright spot in our analysis, however. Some of the bearish signals that we outlined are likely to reverse later this year, leading to a new bull market for stock index futures in 2009.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.

Alan Bush has been a commodity analyst since 1976 focusing on the fundamental and technical aspects of stock index, interest rate and foreign currency markets. He has authored several articles for Stocks Futures and Options magazine and produced the "Futures Tech Focus" program, which is a technically based market outlook.

Alan served on the faculty of Oakton College as instructor of a course entitled, "Principles of Technical Analysis." He has been interviewed on many national television programs, appearing on the Nightly Business Report, CNBC, CNN Moneyline, Reuters Television and Web FN. In addition, he has been frequently quoted in The Wall Street Journal, USA Today, The Bond Buyer and the Chicago Tribune and has been regularly interviewed on Chicago's WMAQ radio business reports.

Alan can be reached at (312) 242-7911, or via email at alan.bush@archerfinancials.com.