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Index Wrap

Inflation is still a dirty word

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Call the FCC, cover the kid's ears, and press the sell button as the word "inflation" and thought of a proactive Fed still on the alert for threats to a steady pace of economic growth found Treasuries and stocks under heavy selling pressure on Tuesday.

Earlier this morning the European Union's statistics office said consumer prices rose 2.3% in December after a 2.2% increase in November, which sparked some fears of inflation overseas.

And while the dollar regained some lost ground against the euro in this morning's trade, as cash flowed back to U.S. assets, the dollar surged against a weighted basket of 6 major currencies as the session progressed, with the U.S. Dollar Index (dx00y) 82.52 +1.50% jumping 1.22 points as I type (04:45 PM EST) after the release of the December 14 FOMC minutes. A word count would reveal the word "inflation" was used 21 times, compared to 15 times in the November 10 minutes.

Some notes from the December 14 meeting that traders and investors might want to be cognizant of were.... "The FOMC's decision in November to raise the intended federal funds rate 25 basis points and its attendant public statement were apparently anticipated by the market, so that the reaction was muted. Subsequently, higher-than-expected inflation data, remarks by the Chairman that were viewed as pointing to future rate increases, and the depreciation of the dollar all led market participants to price in a somewhat steeper path for future policy. The upward revision in policy expectations prompted modest increases in shorter-term Treasury coupon security yields. The yield on the ten-year Treasury note, however, was unchanged on net. Yields on both investment-grade and speculative-grade corporate bonds edged lower. The value of the dollar relative to other major currencies declined."

With that bit of Fed history being revealed, with was the following commentary that spooked investors, and more than likely had profitable bulls further locking in gains, as Treasuries and stocks extended losses from the 02:00 hour.

"With some economic slack persisting and longer-term inflation expectations well-anchored, inflation was anticipated to remain subdued. A number of participants cited the recent depreciation of the dollar on foreign exchange markets, elevated energy costs, and the possibility of a slowing in underlying productivity growth as factors tending to boost the upside risks to their inflation outlook, though, on net, they saw the risks to stable underlying inflation as still balanced."

If I (Jeff Bailey) were to give a trader's translation to the above paragraph, I'd pick out the NEGATIVES (reason to take further profits in a declining session), and read the FOMC, even if inaccurate, or way out of context as, "Economic slack combined with the dollar's weakness and still high energy prices, combined with slowing productivity, will have the Fed continuing its path of raising rates as inflation could become a major problem!"

If you would like to read the full release of the FOMC December 14, minutes, you can do so by clicking this link.

U.S. Market Watch / Internals - 01/04/05 Close

A jump in November factory orders, which was released at 10:00 AM EST received a buy program premium and had the majors lifting to their best levels of the session. But that buy program premium may have been out of politeness as I was bearishly surprised to see so few 52-week high highs, especially at the NYSE. Even Google (NASDAQ:GOOG) $194.50 -4.05% was unable to best Monday's all-time high in early morning trade.

Note today's number of new highs at the big board versus a greater number at the NASDAQ. This is a change, or some DIVERGENCE from the past, with the number of new highs at the NASDAQ suddenly outnumbering those at the NYSE.

What have we been observing in recent months and weeks? The NYSE has "always" posted a greater number of new highs by the close.

I just looked at yesterday's internals from last night's wrap and see that at 10:00 AM EST, the NASDAQ new highs were slightly better than that found at the NSYE, but by the close, the more institutionally held NYSE-listed stocks pressed their new highs further above. I've always felt the NYSE was more institutionally HELD, while the NASDAQ is institutionally TRADED.

While the bullish % indications we track each morning in the 09:00 AM EST update only track the percentage of stocks giving reversing higher point and figure buy signals, or reversing lower point and figure sell signals, I'll make a BEARISH note here that the number of new highs among 1, 2 and 3-lettered stocks starts to wane.

I'll build on this in a minute, and something I looked at last week, but had forgotten about until late this afternoon as it relates to a chart we had built on the NYSE Composite ($NYA.X) 7,090.52 -1.24% a couple of months ago.

Volumes were heavy, not "brisk" today, and selling was BROAD, as if bulls were poised to throw out the New Year's baby with the bathwater.

The NASDAQ Composite (COMPX) 2,107.86 -2.05% suffered its worst single-session decline in 5-months.

U.S. Market Watch - 01/04/05 Close

Dollar selling "usually translates" to foreign capital at least moving into Treasuries. Nope.... not today, and over the past 5 and 20-day's, we would have seen a net outflow of capital from the shorter-dated 5-year yield ($FVX.X) with jumped 7.7 basis points to 3.705%. Corporate bonds didn't find much buying as a quick review of the Beetle's Balanced Benchmark had the iShares GS $ Invest (AMEX:LQD) $111.62 -0.56% down 63 cents. "Junk Bonds" as depicted by the Pacholder High Yield (NYSE:PHF) $9.75 -0.81%, despite its $0.075 per month dividend was also weak.

Hmmmm.... the FOMC notes mentioned all bond asset classes in their notes, how the markets treated each asset class, despite the FOMC's inflation-threatening thoughts that dollar weakness and still high energy prices might have on the economy going forward.

So if their is dollar strength (money coming back to the U.S. = demand) yet Treasuries, corporate bonds, junk bonds and equities were weak, where in the heck is the money going?

Likely answer: To the sidelines!

Earlier in the wrap I said I wanted to build on the NYSE NH/NL observations as well as its bullish % ($BPNYA) readings. Here's a chart we constructed a couple of months ago, when the NYSE looked poised to break out to all-time highs. Target selling and profit taking? Or sudden realization that "inflation" is a problem?

My thoughts are that "inflation thoughts" were used as an excuse to take more profits, and kept would-be buyers on the sidelines.

NYSE Composite ($NYA.X) Chart - Daily Intervals

A sharp 2-day decline after the NYSE Comp. had achieved 100% of our fitted 38.2% retracement and a narrow "zone" from 7,258-7,273 smells/looks like target selling and profit taking. Add in a notably fewer number of new highs on the NYSE and important near- term support from 7057-7,092 is identified.

I benchmarked the 12/14/04 date of the most recent FOMC meeting.

The above chart was displayed in the 11/04/04 Index Trader Wrap. As time has passed from that wrap, the current bullish vertical count from the point and figure chart (20-point box size), which has been fully constructed, hints at a longer-term bullish price objective of 7,540, which would be negated with a trade at 7,080.

Russell 2000 Growth iShares (AMEX:IWO) Chart - Daily Intervals

Index trading was "tough" in 2004 and it could be tough again in 2005. Today, traders may have been stopped out in their final 1/2 bullish position from a seasonally bullish trade we had set up back in late October.

When reviewing the trade, one has to at least give thought that "target selling" and perhaps "tax gain selling" is playing a role in the markets right now.

Today's close "two levels below" after closes right at $67.74 in late December, would be a signal for weakness based on tests we derived back in the October 31, 2004 Ask the Analyst column titled "Best 6 months starts in November."

Pivot Matrix -

All equity-based indices in our WEEKLY Pivot matrix traded and CLOSED below their WEEKLY S2. I've quickly gone back to earlier last year (2004), and it was for the WEEK of 03/08-03/12 that all of the equity-based indices traded below their WEEKLY S2.

I'll post the 03/08-03/12 to 03/22-03/26 set of WEEKLY Pivots in tonight's Market Monitor when I'm done here, and try to the ranges, and levels of trade the following week, to try and ascertain further SIMILARITY or DIVERGENCE for the weeks ahead.

However, based on one of last night's observations of a lower trade in the MONTHLY Pivot matrix, which was DIVERGENCE to early January of last year, I would have to be more BEARISH, if not more cautious in my bullish thoughts currently.

Jeff Bailey

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