Frustrating. Period.

Anyone who follows financial markets long enough has experienced a time when seemingly everything makes no sense.  Given the ever-changing nature of the markets, I suppose this should be expected.  Markets are one of those unique creatures that morph faster than most can adapt.  And just like a baseball player mired in a hitting slump, these nonsensical times are among the most frustrating periods for investors.  The only solace, like that of the big league slugger, is the knowledge that the cloud of misunderstanding will likely lift as quickly as it rolled in.  As someone who has been in the midst of his own ‘slump’ during the past month, today’s market action did little to foreshadow an end to this confusing environment.

As I mentioned last night, I expected the equity markets to trade in a fairly uneventful manner prior to the release of the Federal Reserve’s interest rate decision.  This notion was null and void immediately upon the market’s open as the S&P 500 dropped about 15 points (-1.4%).  Interestingly, much of the commentary underlying the negative sentiment prior to today’s open seemed to echo some of the concerns I raised last night.  Specifically, many commentators asked how the markets could look upon an increase in Federal Reserve intervention as anything but a negative sign for the markets when such a move would imply that the fundamentals of the U.S. economy remained tenuous at best.  While I obviously agreed with that conclusion, the fact that investors seemed to pivot from the ‘Fed action is good’ camp to the ‘Fed action is bad’ chorus as quickly as they did was quite surprising.  And with the release of the Fed’s statement, equity markets pared most of their losses and finished the day practically where they closed last Friday.  Again, it’s like yesterday never happened and today’s Fed statement was a non-starter.  Unbelievable.

For those who didn’t get a chance to read the Federal Reserve’s statement, here are the highlights:

Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months…..Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls…..Bank lending has continued to contract…..the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

And the verbiage that so many had been waiting for:

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.

To be sure, there’s not much in this release that differs from what the market had already expected since this is mostly a rehash of Chairman Bernanke’s Congressional testimony.  Perhaps this is why the markets finished somewhat unchanged, though it’s hard to know for certain.  Subsequent information from the Fed has stated that these newly announced Treasury purchases will be comprised of 2 to 10 year maturities.  Needless to say, this drove Treasury rates down particularly hard towards the close.  Two, five, and ten year Treasuries saw their yields fall by 1.18, 7.66, and 6.08 basis points respectively, while the thirty year yield remained relatively flat at 4.0078%.  Whether or not the Fed will be able to hold longer term rates down for their ‘extended period’ remains to be seen though.

Outside of the equity and fixed income markets, crude oil saw a decent amount of selling on the day.  However, once again, the market held above the $80/barrel level despite falling to an intraday low of $79.20.  This is the kind of resiliency I like to see in a market.  It tells me that despite any headwinds that are lingering, this market has an upward bias.  Gold also saw this kind of trading action today.  After falling to $1,191/oz. early in the day’s session, traders bid prices higher and managed to post a close above the critical $1,204 level.  While a close above this level for more than a single session remains to be seen, gold bulls have to be encouraged by today’s price action.  For my part, I continue to lean to the bear case, but am weakening in that stance with each passing day.  If gold can simply maintain its current price level for the rest of the week that will go a long way towards shifting me back into the bull camp.  Some improvement in the weekly chart’s RSI and MACD profiles would also help.

Well as the opening paragraph of this post implied, I’m struggling to get my arms around this market.  The prospects for the slow drift higher during the month of August I have been expecting appear to be evaporating as fast as the daily trading volumes.  And with so much conflicting data coming out of corporations and the economic indicators, I think it’s fair to say that I’m not alone in my confusion.  However, this collective paralysis isn’t likely to last forever.  This means that when the market breaks, it’s going to be a sharp, head spinning event.  As a result, we need to be cautious in our investment selection in here and mindful of the larger context in which we find ourselves.  As I’ve outlined previously, the prospects for continued earnings growth during the second half of 2010 are challenging and, therefore, necessitate a defensive portfolio structure.  Cash may not be sexy, but it could be a great place to be if/when multiples compress.  While there’s an argument to be made for Treasuries in such an environment, I’m hesitant to jump in with yields as low as they are.  Guys like David Rosenberg would say that historical data proves that yields can move lower.  And he’s right.  However, for me, the potential gains of such a trade are outweighed by the risks of being wrong.  So for now, I’ll continue to look for small scale, short term trading opportunities to supplement my largely cash-based portfolio.  Until tomorrow…..