Equity Index Update

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Brad Sullivan

“Coleman, it was all a dream, a terrible awful dream.”
So says Louis Winthorpe III in Trading Places…

Indeed shorts came across one of the most painful of sessions in a long, long time. Wasn’t it just a scant week ago that the SPX undercut the trading low for our recent move lower and the DJIA broke below 12,000? Ah, what a few words – or in this case, absence of wording can do for a marketplace. In removing the tightening bias from their statement, the FOMC set off the buy stop heard round the world. How aggressive was the pandemonium? In the first 5 minutes after the announcement, the SPmini contract traded over 124,000 contracts with a face value of NEARLY $9BILLION. At the end of the first 30 minutes of trading post – FED, the contract traded a value of over $33 BILLION.

Rumors were abundant that institutional buy stop orders were triggered above 1430, 1437, 1441 and 1445 in the SPM7 contract. By the time the bell rang the indices, as a collection, rested just beneath February 27th levels and have seemingly announced to the world that this correction has run its course. Again…what a difference a week makes. One interesting area of trading has been the performance of the long end of the curve since the announcement. Initially, the bonds surged higher…today they rest -18/32 from yesterday’s close as players have time to reassess some of the initial thoughts. For index buyers this is not the scenario they wish to play out. Keep a close eye on potential trigger points across all markets the next several days as we adjust to this new found optimism.

A quick note on the internals…the NDX cumulative breadth reading (2006 start date) has rallied significantly since last week and now rests just below recent highs. In addition, the SPX (top 100 issues only) cumulative breadth reading reached a new high with yesterday’s close (2006 start date). These readings are used as a thermometer, and right now it appears as though there may be more upside to come.

Heard on the CME Floor

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From our Virtual Trading Room Transcript
March 21, 2007
about 1214 PDT

Brad_Sullivan> hearing that LOTS of buystops
Brad_Sullivan> were triggered
Brad_Sullivan> throughout this move
Brad_Sullivan> on the institutional side
Brad_Sullivan> worth remembering
Brad_Sullivan> most RATE CUTS
Brad_Sullivan> are net bearish for the index markets
Brad_Sullivan> 6 months out
Brad_Sullivan> keep a close eye on 810.50 in ER2 M7
Brad_Sullivan> and 1440.50 in SP M7
Brad_Sullivan> if we keep drifting lower

Equity Index Update

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Brad Sullivan

The index market continues to mirror its recent behavior of Yen/Dollar watching and is called to open higher by nearly 0.5% this morning in the SPM contract at 1406.50. The Yen/Dollar has fallen by about -0.7% relieving fears of the carry trade unwind – at least for the time being. This week is highlighted by the FOMC 2-day meeting that begins tomorrow and concludes with Wednesday afternoon’s statement. Typically, the indices have rallied into and through these meetings over the past several instances…however, with a peculiar batch of economic data it appears difficult for the market to get a clean gauge on Dr. Bernanke’s next play.

On the Monday merger mania front…Barclays Bank and ABN Amro are in discussions to merge and become a $160 billion behemoth. Even the once “given up for dead” Service Master was able to find a buyer in Private Equity Land for nearly $5 billion. If one adds the Blackstone IPO to this picture, it is hard to be overtly bearish looking down the road. I certainly do not want that statement to be misconstrued as the Sub-Prime blowout may have ramifications that we do not see on the horizon…however, I always try and construct my ideas around the money…Follow the money, is a message I try and repeat to myself when I think the markets are at a crossroads. Simply put, the liquidity driven marketplace remains intact and that is being seen in the appetite for deals. Let’s not forget that somehow LEND was able to find a buyer for some of its debt leading to rally in the entire Sub-prime sector. In my opinion, the short term picture remains shaky, but, it is worth reminding ourselves how resilient this equity market has been during this bull move. The fact remains that this is a liquidity driven bull market. Fears are rampant about the Carry trade being unwound and if something triggers a mass covering it would be awfully ugly for the indices. However, if the unwinding is gentle one has to wonder if the worst of this move is behind us.

As for short term trading, the best indicators for market direction remain GS, GOOG and the YEN/Dollar. Odds appear to favor a short term bracketing in the trade as we move from one end to the other in a range around 1.5% in the SPX.

Equity Index Update

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Brad Sullivan

BEWARE THE IDES OF MARCH…so warned Mr. Shakespeare long, long ago. Maybe he should have written beware selling new lows for the move in the index markets the day before the ides of March. The tide turned awfully fast across the board for those trading indices yesterday in the late morning. After undercutting the previous lows made from our downdraft in the last two weeks buyers came rushing in and fresh shorts were forced to pay up in order to cover. When the dust settled it was a fabulous show of strength from the Hedgies ahead of this critical expiration…and to that end I say touché.

This morning the index markets, which had been trading higher earlier, are called to open lower on the heels of our PPI reading this morning. The reading came in at +1.3 on the headline and +0.4 on the core…well above expectations on both counts. However, this reading is notoriously volatile and fickle – my assumption is that the markets will wait until we get tomorrow’s CPI before making any rush to judgment about inflation. Accordingly, I would take this open with a grain of salt and assume that the path of least resistance will be towards the upside.

March Madness begins today, I would anticipate a lightening of the volume by mid-morning ahead of this annual gambling extravaganza. Beware…

Equity Index Update

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Brad Sullivan

Was it the other shoe…or did we just untie it? That is the question, and the only question that really matters facing the domestic and global index markets over the next several weeks. Yesterday’s severe decline was the 2nd such implosion over the last 11 sessions and laid to rest the silly notion that the massive selling from two weeks ago was due to a computer glitch revolving around the DJIA pricing. Given the complete lack of volume on any of the higher sessions during this bounce phase, yesterday’s action does not come as a total surprise. Sooner or later something would trigger another round of selling and the fact that it happened during expiration only exaggerates the move. More importantly, this downdraft may continue to spiral lower due to the expiration of options and futures this week. I have continued to point out that the favorite fund game on the board over the last 3 trading years has been to sell naked puts…when the jig is up on expiration week the moves, potentially speaking, can become quite severe. Yesterday morning I commented that this market had about 5% of downside risk by Friday. After yesterday, we are only 3% away. While I felt the odds of such a trade were remote, they have increased dramatically after yesterday’s action and those that are speculatively short --- particularly those that have watched out of the money puts become in the money --- are faced with the decision as to take in some of the position, all of the position or none of the position. Personally I took in enough yesterday to give me a free roll + profits no matter what plays out from here.

Subprime...I am wondering if it will become a verb in the next few years, like “Homer” in the classic Simpson’s episode where Homer’s constant idiocy becomes a cult classic of “ oop’s I did a Homer” when making a mistake. Only time will tell. But, there is no question that this fiasco lit the fuse yesterday. Accredited Home Lenders (LEND) got the ball rolling saying it was in financial trouble and in need of waivers on outstanding debt. New Century (NEW) was delisted from the NYSE and closed at .85 on the pink sheets. Bear Stearns is the supposed target of subpoena’s on bullish research in this zone. Essentially, we are watching a implosion of a financial product that created affordable homes and thousands of jobs – Savings and Loan scandal anyone? This will end when there is no longer a purely subprime lender left in the building, and at the rate of descent, that may happen sooner than one can imagine. The only question that matters within this arena is will this meltdown trickle through the broader economy? If it does, as many of the bears are forecasting, the result will be recessionary in nature. After a choppy overnight session, the indices have caught a bid from their respective lows and are called to open around UNCH. The Yen/Dollar is trading around UNCH as well after having been well bid earlier in the evening session. Keep a close eye on all product classes today as yesterday’s equity market action drove prices lower in grains, gold, crude and higher in treasuries. Funds are forced to push out positions in one market as their other positions lose value…sell beans, sell SPM7 for example. I don’t expect that to change anytime soon.

Equity Index Update

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Brad Sullivan

The index markets are called to open at or near their respective low trading zones over the past 3 trading sessions. A combination of the sub-prime lending blowup, a weak retail sales report and – most importantly – whispers of INFLATION out of the BOJ last night has produced another big leg of unwinding in the YEN carry trade. On the flip side, GS produced blow out numbers on its quarterly earnings report released this morning…keep a close eye on this stock as it has been our proxy over the last several months.

One of the concerns behind yesterday’s small move higher was the complete lack of volume. It seemed as though it was a holiday trade yesterday as players were on the sidelines…this morning it appears players have awoken from their collective slumber and appear ready to monitor their collective portfolio risk. One key aspect of the trade that few have discussed is the expiration week that we are currently 1/5th of the way through.

Since our massive selling 2 weeks ago today, the indices have been able to hold at higher, but rather uninspired levels. There is little question that this move has been propped by large demand amongst the funds as they try and protect their favorite trade of selling options. If there were to be an unwinding this week of the YEN/DOLLAR it would have dramatic ramifications on the index market. Players are holding their breadth that this does not turn out to be the case, but, if they must let their positioning go due to the risk department LOOK OUT. Certainly the odds of such an event are outlier by definition. However, when looking at such events in a historical context there is always a trigger. The index markets are faced with a POTENTIAL trigger of a YEN carry unwinding that forces index positions out of portfolios creating a vacuum of selling. If this scenario plays out – I would suspect the SPX would fall roughly -4% by Friday’s close from current levels. Keep in mind that the probability of such a happening is small – perhaps as little as 5% to 10% so any plays on this theory should be done with ample speculative cash.

Finally, keep a close eye on GS…a reversal below 200 would put the overall market in jeopardy.

Equity Index Update

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Brad Sullivan

The index markets gapped open strongly for the second session this week on the heels of a large scale reversal in the Yen vs. all its major counterparts. The reason behind the latest Yen move seems to be the rate hike in New Zealand to 7.25% will allow some of the favored carry countries to continue participating in the infamous lever trade. In response to this move in the Yen, the index markets rallied sharply overnight and continued their gains throughout much of a rather quiet session ahead of today’s February Employment Report released by BLS.

The report this morning came in right around consensus expectations on all levels…and that produced a sharp pre-opening bid in the marketplace. Currently the SPM7 contract is trading at 1424.50, which would equate to roughly 1410 in SP500 Cash index. Using the cash market, 1410 to 1415 should provide significant resistance in today’s session.


The real key behind today’s action will be whether or not the indices can hold their opening rounds of buying. Typically on Employment sessions, the move is fast and violent in the first hour, followed by a counter chop oriented trade. I suspect that will play out today, with one exception and that will be the final hour of trading. I expect to see selling across the index complex during that time frame…remember – since last Tuesday’s debacle, the final hour produced only 1 higher close. And that was a total of 0.30 points in the SPX market.

However we settle out today’s session, next week should provide fireworks as we enter the week of “witching.” There are lots of nervous positions on the books of hedge funds right now…and the fact that these bounces have occurred during overnight hours shows how much “supporting of positions” there continues to be in the marketplace. Next week should provide all the answers needed…if there is a forced liquidation trade during expiration week it will be very ugly. Keep in mind that last year we witnessed consecutive massive legs lower in May and June during their expiration weeks.

Some Stats on Last Week's Market Free Fall

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From our Virtual Trading Room Transcript

08:18:50 PST> Brad_Sullivan: Here is a few things I ran through this morning on the move and its magnitude:

From the summer lows, the Russell 2k rallied 20%ish and retraced that rally by 50% with the recent drop;

The SPX rallied +19% and retraced 37% of the move;

The DJIA rallied nearly +19% and retraced 25.5%;

The Midcap rallied +19.5% and retraced 43%;

Finally the NDX rallied 27% and retraced 35% of its move.

In a nutshell what took roughly 7 months to build crumbled in one week we may rally from here and hold serve above 1400 SPX for a stretch, but sooner or later, leg #2 is coming and my guess is that it will be as vicious.

Equity Index Update

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Brad Sullivan

The index markets are called to open sharply higher after reassuring comments from Treasury Secretary Paulson and a move lower in the Yen/Dollar carry trade. The bid began in earnest last night after a horrid final 30 minutes of trading across the index complex. Once again, each index settled below their respective cash instruments and fair value…however, strong bids began to enter the market moments after Paulson’s comments and the SPH moved rather quickly from 1373 to 1386 the European open. Since that time, the indices have treaded water between 1389 and 1382.50.

Today’s action should be defined by this gap open and whether or not there is any push towards filling it. If the indices are unable to hold higher levels we should see increased selling as the session wears on, particularly in the final 45 minutes…a stretch of time that has produced heavy one way street selling the last 2 sessions. If the indices are able to hold their opening bid, I would look for a sharp move higher that would carry the market above their respective highs from yesterday and test the breakdown level from Friday afternoon. In the SPH7 this would equate to roughly 1394 to 1396.

One aspect of the trade that I would put forward is this…we have moved DRAMATICALLY lower in 5 trading sessions. At some point we will get a bounce that sustains – normally that happens after a sharp down morning as the market reverses course in the afternoon. Given today’s gap higher, I have a hard time believing that this will be day we rally +2%...but you never do know.

Equity Index Update

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Brad Sullivan

The index markets continued to suffer on Friday as buyers failed to materialize at levels around unchanged for the second consecutive session. Sellers took control through the lunch trade and became aggressive in the final 30 minutes of trading. It struck me that most of the selling done during that period was of “forced” nature. Whether it be risk managers or margin clerks, the bosses did not want the weekend risk and pushed out longs. Given our lower open today, that seems like a rather prudent trade.

This morning, the indices are called lower, -800 in the SPH7 at 1377.75, but off its overnight trading lows of 1371. The real volatility this morning seems to be lurking in the currency market which is absolutely up for grabs depending upon which cross you are trading. The Dollar is markedly higher against nearly all its counterparts, save the YEN…the YEN/Dollar continues to sink, the change being about +1% in favor of the YEN this morning. On the flip side, the Dollar is up over +1% vs. the Pound and nearly +1% vs. the Euro…the one thing each currency has in common is that they are all SHARPLY lower vs. the YEN. To put this in perspective, 5 sessions ago, the Euro/Yen cross hit an all-time high. Currently, we are trading -5.3% lower from that mark. Certainly, any levered product moving so quickly has the potential to inflict serious damage across the markets. We have seen the response in our index markets as funds are forced to exit long strategies on equities and short yen positions…an ugly mix.


The question now becomes…where do we go from here? How much more damage is left in the system? Is there systematic risk in the marketplace and if so is that risk not being accounted for (in implied volatility) properly? These questions are the larger ones and whichever trading theme one takes in response will yield either a tremendous bout of profitability or a painful loss…of course that is the point for choosing this business.

One aspect of the trade that I try and remind myself of during this volatility is ANTICIPATION. I am reminded of the axiom that Bobby Knight used for his players…C.A.R.R.E. Concentrate Anticipate Recognize React Execute. Pretty simple stuff…but it works. In these markets many of the larger moves are actually quite orderly (Tuesday afternoon being an obvious exception). However, if you examine Friday’s action in the SPH7…we traded up to UNCHG at 1405 and eventually settled at 1385.75. Most of that action was steady selling with some spike program action involved…however, if you were selling low prints on the way down the market clearly tested your position, bouncing higher quite easily. The key with trading in this environment is to wait…wait until you see the “whites of their eyes” as one of my friends used to say.

Equity Index Update

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Brad Sullivan

THE UNWINDING CONTINUES…yes the infamous carry trade continues to dominate the trading headlines and collective minds of participants. Just how far and how fast the Yen travels vs. the Dollar, Euro, Kiwi, Rand and Aussie remains to be seen…but the velocity with which it has come so far this week shows that liquidation remains the name of the game. This morning, things were relatively docile in Europe…then the YEN started to pick up strength and before one could blink an eye, the SPH7 dropped from 1405 to 1396. Given the dramatic increase in volatility it should be expected that these moves will continue over the next several weeks.

Yesterday’s action was dramatic and quick. Indeed if one were fortunate enough to buy the dip off the initial opening bell sale, it proved to be a tremendous month of profits by the end of the first hour of trading. The remainder of the session consisted of strong bids lying in wait underneath the higher pricing zones. However, each index failed to hold their unchanged levels – and more importantly were sold lower rather easily in the final hour trading. The impact of today’s carry lower overnight should provide ample opportunity in today’s session.

One of the keys today will be the response to the Yen/Dollar trade…earlier this morning, the YEN traded to a new high for the move, up about +3% on the week vs. the dollar. Since that high print, the YEN has come off a bit and that has corresponded with a bounce in the SPH7 from 1393.50 to 1399.50. Obviously…we can see the trend in the overnight markets in terms of taking their direction from this trade. However, it is not as clear that this indicator will work as well during our day session. In other words…utilize the YEN/Dollar as a trading input, but not as sole discretion for a trade.

Sullivan talked .....the Market listened !

Tweet Sullivan talked .....the Market listened !

From our Virtual Trading Room Transcript

11:57:14 PST> Fari_Hamzei : 2 min before last hour begins
12:00:15 PST> Fari_Hamzei : what happened with SLV ?
12:00:54 PST> Fari_Hamzei : weekly outside bar reversal completed today !!
12:04:28 PST> Thomas_Bohn : we turned when treasuries sold off
12:05:09 PST> Thomas_Bohn : if that was the source of funds
12:05:19 PST> Thomas_Bohn : to buy equities
12:05:36 PST> Thomas_Bohn : the buying may be done
12:07:09 PST> Fari_Hamzei : Ken, are you happy now ?
12:10:41 PST> Ken_McCue : I am always happy!
12:13:34 PST> Ken_McCue : Interesting divergence between the BCs and the ES / SPX
12:14:10 PST> Fari_Hamzei : yes but not between HBs and NQ
12:14:17 PST> Fari_Hamzei : BUY pgms
12:14:25 PST> Fari_Hamzei : high TICK again
12:16:10 PST> Thomas_Hall : yen not really losing its bid though
12:20:03 PST> Brad_Sullivan : I think
12:20:09 PST> Brad_Sullivan : the key of bottoming
12:20:15 PST> Brad_Sullivan : is how we finish this hour
12:20:27 PST> Brad_Sullivan : sellers came in right at the stroke of 2:00 pm CST
12:20:50 PST> Brad_Sullivan : the final 30 minutes
12:20:53 PST> Brad_Sullivan : should be eventful
12:20:57 PST> Brad_Sullivan : any push
12:21:00 PST> Brad_Sullivan : below
12:21:05 PST> Brad_Sullivan : 1404 in SP H7
12:21:16 PST> Brad_Sullivan : on a settlement basis
12:21:29 PST> Brad_Sullivan : would leave me wondering
12:21:34 PST> Brad_Sullivan : if this was not a setup
12:21:38 PST> Brad_Sullivan : for more downside
12:21:40 PST> Brad_Sullivan : next week
12:22:03 PST> Fari_Hamzei : we will see a vol retest
12:22:12 PST> Fari_Hamzei : maybe sooner that later
12:22:15 PST> Fari_Hamzei : i favor later
12:22:27 PST> Fari_Hamzei : when everyone is very comfy
12:22:49 PST> Thomas_Bohn : very good points
12:23:02 PST> Thomas_Bohn : if they can't finish the job
12:23:12 PST> Thomas_Bohn : it won't look good
12:23:16 PST> Brad_Sullivan : right
12:23:18 PST> Brad_Sullivan : in addition
12:23:23 PST> Brad_Sullivan : the move up
12:23:30 PST> Brad_Sullivan : was on very light volume
12:23:41 PST> Brad_Sullivan : NOT THE EARLY REVERSAL UPDRAFT
12:23:45 PST> Brad_Sullivan : but the move
12:23:52 PST> Brad_Sullivan : from 11:30 to 2:00
12:26:45 PST> Thomas_Bohn : Sullivan talked .....the market listened !
12:29:24 PST> Ken_McCue : Yep good call - pyshic?
12:29:41 PST> Thomas_Bohn : very nice Brad
12:30:02 PST> Brad_Sullivan : every now and then
12:30:10 PST> Fari_Hamzei : LOL

Equity Index Update

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Brad Sullivan

Driving into work this morning I was listening to a local Chicago radio station when the news report came on and the pre – news conversation turned to yesterday’s decline in the equity markets. This show is anything but serious and I was struck when the star of the show said his brother was a stockbroker and how he wanted him to buy during yesterday’s decline. This prompted the news reporter to talk about how traders woke up to the Asian bloodletting yesterday and just kept on selling…but it will come back, like it always does.

Normally, on the heels of such a whipping, I reverse course and become a buyer…and I was up much of the night trading on that very theme. However, those were trades to take specific advantage of the enormous discount we settled at to fair value yesterday across the index board. That trade has played out as the indices are called to open sharply higher from settlement, but around their respective fair values. Now…things become a bit more difficult. Certainly, I was a bit surprised to hear such complacent talk after a -4% decline on the morning radio. Could this be a sign that there is more to come on the downside?

It is worth noting that the SP minis traded a whopping 3.5 million contracts in yesterday’s action…that equates to the single largest volume session in this contract's history by nearly 50%. In addition the volatility that captured the market after the much discussed computer glitch in the DJIA calculations seemed to catch everybody searching for answers. There is no question that the move was heart wrenching to the downside, but after watching Cramerica last night, I have to wonder if there is not just a little too much cheerleading and explanation of the decline for there to not be more – and potentially much more behind this downdraft. I remain steadfast that this move picked up acceleration with the strong drop in Yen/Dollar and the unwinding of the infamous Carry Trade. As I write this…the Yen is rallying to highs for the session vs. the Dollar and the index market is buckling. It is and will continue to be the number one indicator in my book moving forward.

---

As for the session today…expect HEAVY doses of volatility and whatever you do…don’t get caught selling bottoms and buying tops because the reversals are lurking behind every tick. I suspect we will have an inside session…most likely inside the final two hours of trading from yesterday. Keep in mind that there will be lots of gunslingers hitting the trade today…utilize a strong plan to stay out of trouble.

Equity Index Update

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Brad Sullivan

This morning the indices are trading sharply lower on the heels of a mini-crash in China where the market lost -9% of its value in their Tuesday session. In addition, the unwinding of the Yen Carry Trade has begun in earnest as the YEN is higher by +1.2% vs. the Dollar overnight. I have said for quite sometime that this is the key, the liquidity primer that has become one of the primary reasons for the decrease in global volatility. Now…if this Carry trade turns into a fiasco of “last one turn out the lights” it will have major negative implications across the global index and commodity markets.

Given that I have laid out the bear case, it is worth noting a couple of key points. IF THE YEN CARRY UNWINDING IS MODERATE IN NATURE, the markets should have little trouble adjusting to this liquidity squeeze. On the flip side…all one needs to do is examine a chart from last years steep selling in the index market --- REMEMBER IT ALL BEGAN WHEN THE YEN RALLIED SHARPLY VERSUS THE DOLLAR ON COMMENTS OUT OF THE BOJ REGARDING THE END OF THE EASING CYCLE. Granted, the subsequent rally was tremendous and has carried the indices to new trading highs. However, being a short term trader we are concerning ourselves with the outlier event…and that is volatility. If I am correct, I suspect that today will usher in a several week period of increased volatility - time to put away the sunscreen or ski boots.

As volatility begins to come back into the marketplace, it will widen the true depth within the bid/ask. We have grown accustom to size up at every tick in the index futures markets – this will subside as market maker programs adjust for the uptick in volatility. Subsequently, this will increase the impact a large order has on the market – for example, an order to sell 1500 sp minis at the market during a liquid time of day may only move the index a couple of ticks. Today, that same order could move the market as much as 1.75. Be prepared for strong program playing and liquidation. In addition, be ready for some quick and aggressive short covering moves.

Equity Index Update

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Brad Sullivan
February 16, 2007

The index markets traded in a light volume narrow range as Dr. Bernanke finished his testimony on Capitol Hill. The SPH7 contract produced a range of 0.4% for the entire session as players held their bids from Wednesday’s sharp advance.

This morning the indices are marked slightly lower on news that MSFT’s Vista software projections are a bit too optimistic. After trading through yesterday’s low in the SPH7 contract, buyers bid the pre-market higher on a rumor that AMR would be taken private in a deal led by GS. The morning’s economic data was right in line on the PPI with a headline reading of -0.6% and a core reading of +0.2%. Housing Starts came in a bit weaker than anticipated. Since that news, the indices have lost their slight bid and now rest around -1.00 pre-open.

We are focusing on an early close in the treasury market, option expiration in the equity markets and a pretty aggressive back and forth trade in the dollar. The Yen carry trade and its potential unwinding is in the back of everybody’s mind. However, I still hold that only a move below 115 in the Yen/Dollar would get the carriers frightened. And if that were to happen, it would be a short term detriment to the equity markets.

Keep a close eye on the “normal” expiration trade, which consists of a sharp mark higher just prior to and through the first minute of the open. Afterwards, look for a break around -0.3% in the SP before sideways action hits.

Equity Index Update

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Brad Sullivan
February 15, 2007

The index markets caught a strong bid on the heels of Fed Chair Bernanke’s testimony on Capitol Hill. Dr. Bernanke gave a rather stunning assessment of the current domestic economy as he came across quite “dovish” versus his global counterparts (Trichet anyone?) on the future direction of interest rates, inflation and employment. On the inflation front …“while we have not had much new information, the recent readings on inflation are encouraging.” Perhaps his key catch phrase was “sustainable and not overheated” when discussing the current economic situation --- Golidlocks is alive.

The index markets did not wait for another utterance from the esteemed Fed Chair as buyers took in 95,000 SP mini contracts from 9:00 to 9:05 cst. An aggressive stance to be certain, and when the dust had cleared new trading highs for the move were established in both the SPX and DJIA. Interestingly, the Russell 2000 felt the brunt of rotational selling and finished the session with slight gains. This highlights the internal strength of the current marketplace. The Russell 2000 broke to new highs after nearly two months of a 3% trading range…in doing so the index rallied around 2.5% from its previous closing high. The SPX remains about -5% below its all-time highs established in the spring of 2000 and retested later that fall. Could we be in a position where the small and mid-cap indices mark time while the SPX makes a run at 1515?

Today is chalk full of data for the markets…and so far it has been generally favorable to “goldilocks.” The Philly Fed data at 11:00 cst always smacks of lunchtime desperation trading, so be cautious.

Equity Index Update

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Brad Sullivan
February 14, 2007

The index markets recaptured the majority of losses associated with Friday’s mid-session plunge. In fact, both the DJIA and Midcap 400 settled within a whisper of all-time highs. Many were explaining the rally on the AA news of a possible takeover, however, that seems a bit too simplistic. The fact remains that since the indices began their steady march higher in August of last year we have survived quite a few vicious one day declines. In each of these instances the sell-side failed to capitalize on any ground, gained both in price and market psychology. Accordingly, a spat of dip buying and short covering pushed the indices to new high territory for the move – will it occur again?

One aspect of the current environment that pushes me towards uneasiness (at least from the selling perspective) is the constant and growing chorus of those anticipating for a correction. The discussion about a -2% correction in the SPX on an intraday basis and low volatility and liquidity and selling premium and too many hedge funds and – well you get the point. These are the ingredients needed for a “melt up”… too many players on the sidelines, expecting a correction in order to get their positioning. The fact is this – if you waited to buy this rally, you would still be waiting. Strong markets do not let you in very easily. This discussion is running counter too much of my writing on Monday of this week. In that piece, I discussed liquidating long positions into Friday’s option expiration. I still believe that is a prudent move…however, at this point, given the information at hand I would liquidate only partial longs.

This morning brings testimony from FED Chairman Ben Bernanke…as he discusses the economic outlook in front congress for the next two days. In addition, we will receive Retail Sales. This morning, the dollar is sharply lower against its European counterparts. One trade that demands examination is the Euro vs. Dollar. The Euro has based for over one month in a narrow 1.5% range, well below the late 2006 contract highs. There is a potential – assuming the Euro closes over 13100 that we could see a sharp rally ensue over the next 6 to 8 weeks.

As for the index markets, all ears will be tuned to Bernanke and particular any comments about inflationary pressures in the economy. So far the new chair (with his one glaring miscue in May of last year) has hit all the correct buttons for the Street. If today is more of the same, we should move higher.

Currencies and S&P 500

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Sally Limantour
February 14, 2007

The Euro is on fire this morning and is now getting back into the value area that was rejected in that last sell off on Jan 3rd –Jan 5th. The market has gone above the resistance area of $1.3055. The European growth data yesterday was friendly and the boost this morning is from remarks by Austrian Central Bank Gov Liebscher when he said the bank is fearful that inflation is going to accelerate. There is other news out today that much of the euro’s rise this morning is due to demand from, “Russian names running into offers from an Asian account defending a $1.3110 barrier.” Market News.

The dollar rejected the 85.00 again and I thought we could see a fast move to test recent highs above 85.00 then fail, but it cannot even do that. Despite falling oil prices and rising bond yields the dollar cannot rally and this now has a feel of taking a more serious downturn.

The S&P (ESH7) opened strongly and had a range extension early on. Stops on short positions were hit at 1444. Closing above 1446.50 is short term bullish and put my short term model into a buy yesterday with stops below 1437 (1430 on cash index). Medium term model is neutral but expect to see a sell off in the next 1-3 months as the probability of a wave of risk aversion is rising.

Cupid Bernanke speaks today and I expect to hear the required inflation warning with the “on hold” theme.

Happy Valentine’s Day!

High Beta Stocks: This Move is Suspect

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From our Virtual Trading Room Transcript
February 13, 2007
about 0730 pst

Brad_Sullivan> pretty good buy program to start the hour
>> Roberta_Brown has joined room #SuperPlatinum
Brad_Sullivan> but...so far no follow
>> Thomas_Hall has left room #SuperPlatinum
[Fari_Hamzei] hi Roberta
[Fari_Hamzei] HBs say this move is suspect
[Fari_Hamzei] we shall see
Thomas_Bohn> yep
Thomas_Bohn> giving it up
Thomas_Bohn> with NQ underperforming now
sent sound: train
[Fari_Hamzei] BUY pgm hits NYSE

Equity Index Update

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Brad Sullivan
February 12, 2007

The index markets took a sharp turn from multiyear/all-time highs around the late morning Friday. The SPH7 contract traded from early morning/contract highs of 1457 to a low made just before the final hour of trading at 1436.75. Heavy selling was reported in the pit – a rarity these days – through Bear Stearns’ desk…the talk was that a fund sold nearly 5,000 SPH7 contracts from 1448 to 1438. Essentially, this puts the index markets in a rather interesting position, just underneath the highs of the move, but losing momentum as the market continues to grind at certain price zones. The question at hand seems to be – what will drive the market over the next several sessions? The answers could be at hand this week as Fed Chairman Ben Bernanke testifies before congress beginning on Wednesday, Retail Sales and PPI later in the week as well as option expiration. Keep in mind this statistic…in 2006 we had a total of 4 expirations that witnessed significant downside price action.

One trend that continued on Friday afternoon was the “mark up” into the session’s end. This phenomenon is particularly strong in the Midcap 400 and Russell 2000 contracts. Both of these contracts rallied 0.4% on closing orders and have once again left a significant differential between the cash market and futures fair value calculations. Over the last two weeks this game of marking ‘em up has been at its strongest during sessions when the indices are lower. Keep this little nugget in the back of your mind during sessions that “look and feel” like they should settle on the lows.

Today’s action should be critical in terms of market psychology. I suspect we will continue to widen our intraday trading ranges, which should lead to a greater opportunity for day traders. Could it be that volatility is starting to show its shadow?