Friday, October 24, 2008

It could have been worse...

Today was a difficult day to try to understand in the markets. Before the bell the S&P 500 futures contract was locked limit down. This hasn't happened in my memory since 1998. I don't think they even locked limit down post 9-11. Then the market rallied off that limit after the open and performed remarkably better than all the other markets in the world. Which is not to say it performed well, it was still down 3.5%. That's a lot, but not by recent standards.

First, by way of explanation the S&P 500 stock index future is a financial product that trades on the Chicago Mercantile Exchange and on the CME's 24 hour trading system Globex. This means that you can check where the S&P is trading with a 20 minute lag 24 hours a day all week at the Merc's website. This allows you to see how the market is responding to events overseas.

The futures contracts at the Merc are subject to limits on how far they can move overnight and during the day. They can at most move 60 points overnight and during the day there are trading halts as the market goes down 10%, 20% 30%. These were instituted after the 1987 stock market crash to try and slow such an event were it to occur again. So overnight in the rest of the world, stockmarkets got crushed. Japan was down 9%, Korea was down 10%, and before the US open European markets were down a similar amount. Therefore people trading the S&P expected a similar thing to happen in the US and so they locked the S&P limit down.

But then something surprising happened. The market rallied in the first few minutes of the day, bounced around during the day but never got back below the down 60 limit for the rest of the day and closing only down 3.5%. Far better than anywhere else in the world. It's hard to know why this is.

One reason might be that US existing home sales were stronger than expected because house prices have been falling faster than expected. This is seen as a good sign because the economy cannot recover until the real estate markets recover. It could also be seen as a bad sign because it means that the values of real estate and real estate debt held by banks are probably going to continue to decline.

So its hard to know what it means that he US was so much stronger than the rest of the world. It probably means that absent more dire news about the real economy markets in the rest of the world will probably rally on Monday. There will probably be a lot of spike rallies as different people, Warren Buffet, Barton Biggs call the bottom. But until the financial world is no longer asking what shoe will drop next, we probably have not seen the end of this.

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