Replies to post #32637 on Short Term Trading Member Forum

[arjunah]

Fundamental Events vs. The Bernanke Put

All three types of fundamental events described by Hurst cause a re-valuation of security prices in light of the new fundamentals affecting the security. Fundamentals will change the amplitude of a price wave, fundamentals will not change the wave period.

You could, however, postpone the bottoming of a price wave through market manipulation apart from fundamental events affecting the price.

Suppose you were a Master of the Universe and you wanted to temporarily sustain a security’s price even though the fundamentals that everyone new about would require a sharp discount of the price. One way to do it would be to keep the securities off the market by working out a deal with the owners in which you give them a put option in return for them not selling during the life of the put. You could also severely punish short-sellers by using your vast resources to buy in the stock whenever they started a run. These are temporal solutions, but if you had enough money and power, like the Fed does, you could postpone a sell-off in the security that would otherwise have occurred given the fundamentals. You could effectively extend the period of the price wave by postponing a sell-off.

A primary purpose of the Fed action taken since August 07 was to prevent the selling of securities. When the Fed swapped $200 billion in Treasuries for mortgage backed securities, it did so to prevent forced sales of those securities that would have been required to meet margin calls. That’s a Bernanke Put. It keeps the securities off the market for the life of the swap.

The Fed has also severely punished short sellers. Why does everyone who’s learned to trade in the last 20 years know (if they know anything) to “never fight the Fed”? Because they have seen what happened to those unfortunate traders who shorted sharp sell-offs, and who were short going into FOMC meetings. They know its never safe to sell short whenever it looks like short selling would be most profitable because the Fed will do whatever it takes to avoid or to reverse a sharp sell-off. That’s another form of the Bernanke Put; it limits downside losses like a put option does.

Without Fed intervention and the fear of it, people would be shorting the sh*t out of this market. But they won’t do it because they know better than to fight the Fed. The Fed has trained them not to sell short when the market looks particularly weak and vulnerable.

This manipulation of the sell-side of the market is not a fundamental event as defined by Hurst. It has relatively little impact on the “fundamental” value of a security. Are those mortgaged-backed securities any more valuable now that the Fed is holding them? No. They are just off the market and won’t be sold for the time being. If the Fed had not intervened, those securities would have been forced on the market. There would have been a blood-bath, the price wave would have bottomed and then we could start over with a new price wave. But the Fed has delayed the day of reckoning. It has postponed the 4.5Y bottom by intervening to restrict the sell-side of the market. And this has nothing to do with fundamental events.

The End.