Depending on your point of view, stocks appear to be set up to either (a) break out to new highs after Wednesday's Fed announcement or (b) dive back into what would then be a very defined trading range.

While the consensus among analysts is that Ben Bernanke will announce a "tapering" of the Fed's QEIII program tomorrow, it is interesting to note that the S&P 500 is now positioned right at its all-time highs in front of the announcement. Interesting indeed.

In order to try and ascertain which team might have an edge here BEFORE Ben Bernanke embarks on the last press conference of his Fed career, we thought it might be a good idea to look back at how we got here. In other words, there might be some value in trying to understand why stocks have been moving coming into today's big event.

How Did We Get Here?

If you will recall, a good portion of the blame for the pullback seen in the stock market this summer was attributed to the "taper tantrum." In short, upon hearing Ben Bernanke mention the possibility of the Fed starting to pull back on its stimulus programs, traders immediately equated the idea to the Fed changing its tune. As a result, stock and bond prices sold off as yields began to move up in earnest.

However, after a painstaking communication campaign by Fed officials, which included both inflation hawks and economic doves, traders finally got the message that starting to remove a small portion of the stimulus being provided to the economy was not the same as the Fed raising rates. However, not before the "taper tantrum" had knocked nearly six percent off of the S&P 500 and the yield on the 10-year had spiked more than one percent.

Part of the Fed's pitch to the markets was the idea that interest rates would continue to stay low for some time. It was communicated that (a) the FOMC would basically never sell some of the mortgage-backed securities it held in its coffers and (b) a fair amount of time would elapse between the end of the current QE program and any actual hiking of rates. As such, the fear of a rate debacle was taken off the table. And the next thing you knew, the stock market indices were making fresh all-time highs.

Stocks then succumbed to another minor sell-off, which amounted to a decline of 4.63 percent over about four weeks. But this time the concern wasn't so much about the Fed, but rather the potential for an armed conflict in the Middle East. Such an event would mean higher oil prices, a pause in economic activity, etc. Regardless of the reason, the price action got ugly for a while and the bears smelled blood.

But as has been the case all year, the pullback ended almost as quickly as it began after it became obvious that Obama had no backing for what could be considered a politically-induced strike against Syria. And after Larry Summers announced that he was no longer interested in Bernanke's job, once again, the S&P 500 finds itself very close to all-time highs.

It is also interesting to note that stocks are back to the high-water mark despite the massive move seen in interest rates. Remember, on May 3, 2013, the yield on the 10-year closed at 1.631%. But as of September 5, that yield had moved up to 2.98%. Thus, investors should take note that although there were definitely some bumps along the way, stocks have been able to head in the same direction as interest rates since Bernanke started talking taper.

So, despite rates nearly doubling, mixed economic performance both home and abroad, the threat of war, the uncertainty over who will be Ben Bernanke's successor, and the expectations that the Fed is going to begin doing its taper dance this afternoon, stocks are sitting at or very near all-time highs. Some will argue that this action means traders are not afraid of "the taper." And if one is being objective, it is hard to argue that this action isn't bullish.

Great Expectations

In terms of what to expect from the Fed meeting today, the general consensus is that the FOMC will indeed begin to "taper" their bond purchase program (aka QEIII) at the conclusion of the meeting. In addition, it is expected that Bernanke will announce cutbacks of between 10 billion and 15 billion dollars. In terms of what the Fed will stop buying, this area is a little less clear. However, since the Treasury market is the most liquid part of the bond market and mortgage-backed securities are more impact-ful on the housing market, it is anticipated that the Fed will begin tapering its purchase of treasuries.

So, how will the market react? This, of course, is the 64,000 dollar question. Everyone knows that stocks tend to be uber-volatile after FOMC meetings, so don't be surprised if the Dow gains or loses (or both) 100 points in short order. And most traders know that the first move off a Fed meeting is the false move. It is where the market ends the day and how it reacts the following day that will matter.

As was discussed in the opening line this morning, the likelihood is that stocks will either break out to fresh all-time highs or dive back into a trading range. However, the good news is that it is fairly easy to come up with a trading strategy based on either outcome.

Click Here For More of Dave M's "Daily State of the Markets" Commentary

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

1. The State of Fed Policy 2. The Next Fed Chairman 3. Fun and Games in Washington (I.E. Debt Ceiling) 4. The Outlook for the U.S./Global Economy

The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Positive (Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Moderately Positive (Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive (Chart below is S&P 500 daily over past 12 months)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

  • Near-Term Support Zone(s) for S&P 500: 1680
  • Near-Term Resistance Zone(s): 1710

The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...

  • Trend and Breadth Confirmation Indicator: Positive
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator: Positive
  • Breadth Thrust Indicator: Positive
  • Bull/Bear Volume Relationship: Moderately Positive
  • Technical Health of 100 Industry Groups: Moderately Positive

The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

  • Overbought/Oversold Condition: The S&P 500 is very overbought from a short-term perspective and is neutral from an intermediate-term point of view.

  • Market Sentiment: Our primary sentiment model is neutral .

The State of the Market Environment

One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward because different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Markets Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.

Weekly State of the Market Model Reading: moderately positive - This tells us to give the bulls the benefit of the doubt at this time.

If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.

Turning To This Morning...

As expected, there is not a great deal of movement in global markets in front of the Fed's announcement scheduled for this afternoon. All eyes will be on the FOMC as they finally tell us their decision on the topic of tapering the current stimulus program known as QEIII. European stocks are firm in the early going and U.S. stock futures are pointing to a slightly higher open.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets: - Japan: +1.35% - Hong Kong: -0.27% - Shanghai: +0.29% - London: +0.13% - Germany: +0.47% - France: +0.54% - Italy: +0.62% - Spain: +0.62%

Crude Oil Futures: +$0.57 to $105.99

Gold: -$7.60 to $1301.80

Dollar: higher against the yen and euro, lower vs pound.

10-Year Bond Yield: Currently trading at 2.863%

Stock Futures Ahead of Open in U.S. (relative to fair value): - S&P 500: +2.59 - Dow Jones Industrial Average: +29 - NASDAQ Composite: +9.42

Thought For The Day...

"I think a hero is an ordinary individual who finds strength to persevere & endure in spite of overwhelming obstacles." -- Christopher Reeve

Looking for Guidance in the Markets?

The Daily Decision: If you want a disciplined approach to managing stock market risk on a daily basis - Check the "Daily Decision" System. Forget the fast money and the latest, greatest option trade. Investors first need is a strategy to keep them "in" the stock market during bull markets and on the sidelines (or short) during bear markets. The Daily Decision system was up 30.3% in 2012, is up more than 25% in 2013, and the system sports an average compound rate of return of more than 30% per year.

The Insiders Portfolio: If you are looking for a truly unique approach to stock picking - Check out The Insiders Portfolio. We buy what those who know their company's best are buying - but ONLY when they are buying heavily! P.S. The Insiders is up over 30% in 2013 and has nearly doubled the S&P 500 since 2009.

The IRA/401K Advisor: Stop ignoring your 401K! Our long-term oriented service designed for IRAs and 401Ks strives to keep accounts positioned on the right side of the markets. This is a service you really can't afford not to use.

The Top 5 Portfolio: We keep things simple here by focusing on our five favorite positions. This concentrated stock portfolio employs a rigorous custom stock selection approach to identify market leaders. Risk management strategies are built in to every position.

All StateoftheMarkets.com Premium Services include a 30-day money-back guarantee!

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Remember, you can receive email alerts for more than 20 free research report alerts from StateoftheMarkets.com including:

  • State's Chart of the Day - Each day we highlight a top rated stock with a positive technical setup
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  • Mission Statement

    At StateoftheMarkets.com, our goal is to provide everything you need to be a more successful investor: The must-read headlines, market commentary, market research, stock analysis, proprietary risk management models, and most importantly actionable portfolios with live trade alerts.

    Finally, we are here to help - so don't hesitate to call with questions, comments, or ideas at 1-877-440-9464.

    Wishing you green screens and all the best for a great day,

    David D. Moenning Founder and Chief Investment Strategist StateoftheMarkets.com

    For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)

    Positions in stocks mentioned: none


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