Tuesday, November 30, 2010

POMO Similar to Anthrax (market history repeats)

While many consider POMO (Permanent Open Market Operations) a net-negative for US markets in the long run, it is widely considered to be a near-term positive for equities. That may no longer be the case (POMO being a positive) and it's important to monitor now.

We're still seeing equities bounce, coincident to POMO valves being opened (during the actual operation). But equities are no longer routinely ending the day higher after the conclusion of a POMO session.

Before POMO is completed, you should be prepared for potential sell programs hitting as POMO actions ensue. The market reactions to anthrax events in 2001 provides an interesting precedent, inversely speaking.

On the heels of 9-11, the onset of anthrax news-breaks negatively affected the market (not surprisingly). Anthrax was never considered to be a positive, but before it was over anthrax was a driver rallying the markets.

It worked like this: After the resumption of trading following 9-11, the market was emotionally charged and news-driven. As anthrax stories began to spread, fear and contagion ensued. Anthrax was a predominant news story for several weeks. Both humans, and certainly markets, fear uncertainty. Anthrax created fearful uncertainty. If the market was open for trading when a new anthrax story hit (which was almost always the case), index futures sell programs were the instantaneous initial response.

The sell programs were severe in the beginning, but consistently the market made near-term lows within a minute of the initial panic. This became fairly obvious, to traders especially, that if you bought into the sell program you could trade-out an hour or two later at reasonably higher prices; as the market slowly worked its way back to the mean from which it had dived.

It's not surprising then, that the sell programs had less and less dramatic impact and after several of these events, there was only a muted response to stories suggesting new anthrax outbreaks.

By the end, there was at least one new anthrax break which led to an immediate buy-program for equities and the market's reaction was an immediate lurch higher. Anthrax had evolved from being a buy on the negative news, to an actual positive. Anthrax became a bullish timing signal to buy stocks.

Yesterday was our first double-POMO session and while the market did manage to recover from early lows, it could not finish the day positive. Today (thus far), equity markets are again broadly lower, coincident to POMO valves open. Yes, we're still bouncing as POMO operation are in process, but the impact is having less and less affect.

POMO is providing liquidity to the markets and the calendar for this inflow is widely distributed (whereas anthrax events were random, presumably). Liquidity is great for bulls, as it generally helps improve prices. But liquidity is an even greater benefit for sellers, larger holders especially, as it provides them the ability to reduce positions without negatively affecting prices. When liquidity rises and prices fall, what you're left with is called distribution. The greater the liquidity, coincident to falling prices, the greater the degree of distribution. Think of distribution as larger holders unloading to more numerous, but weaker hands.

The market reactions to anthrax indicated clear signs of accumulation (large holders buying into the negative news as smaller selling hands increased liquidity). The way POMO is progressing now, I will not be surprised to see net-selling ensue as POMO valves open. Should this become a reality, the market won't take forever to figure it out. And...

POMO would then become a near-term negative, in addition to whatever long-term impact it may or may not hold.

I love POMO, since it provides such an easy means with which to measure broad-market strength. If equities rise broadly while a chorus of criticisms attack the policy, I know I should position long. And at the same time, if equities sell broadly, in spite of POMO liquidity, then I know I want to be short.

Like anthrax, POMO makes the game easy to play, by defining the true strength underlying the market.

-Equity accounts currently 1.28-1 net-long, 79% invested

-Follow Centrifugal to fade trades in real time

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