Pisani: Shorts and the Fed 'Set Up'

Ben we hardly knew ye.

For the second time in a month, Bernanke and Co. have burned the shorts -- badly.

I moderated an Institutional Investor Family Wealth conference over the weekend, and the opinion of the hedge fund managers and strategists assembled was nearly unanimous: the Fed would cut rates 25 basis points and issue a statement on concerns about higher energy costs. Since this was priced in, markets would drop briefly, then recover.

Wrong. Traders were particularly incensed that the decision was unanimous a few days after a number of Federal Reserve officials implied they were at best neutral on a rate cut, and many reiterated they would not bail out bad investments. Last night, I heard comments like "the Fed set us up" and that Fed official comments last week were a "misdirection play."

Bears like Doug Kass are not happy. In his morning note, Kass noted that "The U.S.'s economic problem lies firmly in the consumer/housing market, and the larger-than-expected rate cut will likely promote further inflation, a downward spiral in the U.S. dollar and, most importantly, will likely raise intermediate and long-dated bond yields."

Regardless of whether the Fed action was correct or not, "Don't Fight the Tape" is still the majority creed, as Ned Davis noted this morning. Mr. Davis noted to his clients that the market had bottomed out August 16th and it was "my belief that a market that will not go down on bad news is temporarily sold-out."

The bottom line: going into the final quarter of the year, many players are behind the curve. Many hedge funds are flat on the year with the S&P 500 up 7 percent; we are 2 percent (35 points) from the S&P's July 19th historic high.

	Price		Change	%Change
S&P 500		---

There are three implications:

1. Having been burned twice (yesterday and August 17, when the Fed cut the discount rate -- on an options expiration!), shorts are unlikely to risk being burned again. Look for the Street to unwind a good part of their short positions (as they did yesterday). Note that there are near-record short interest on the S&P 500, coupled with very high insider buying.
2. Many traders will, once again, be forced to go long and pray the market momentum (and a few good stock picks) will break their way.
3. Some traders are noting that the combination of accommodative U.S. monetary policy with continued strong Chinese growth will continue to support enthusiasm for Hong Kong stocks.

Note: According to Credit Suisse, since 1984, 100 percent of the time after the first Fed cut, equities are higher one month later. The only occasion when they failed to be higher one year later was in 2001 when there was a valuation, economic and corporate leverage problem.

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