The Rally Before the Rally
With investors expecting a rally following the FOMC meeting tomorrow, the very act of taking an early position sent the Dow and the NASDAQ markets ahead today. Does that limit the upside tomorrow once the announcement of higher rates (foregone conclusion) hits the airwaves at 2:15 ET? Not in our opinion. Today's rally came on extremely low volume indicating more a lack of sellers than "bucket-o-buyers". In fact, based on the last three days of gains, sellers have all but evaporated leaving only a few active but brave soles in charge of buying. It's the same old story - nobody is willing to lead the bullish herd out of the current trading range until Cowboy Al (Alan Greenspan) pulls the trigger on interest rates.
Here's the deal. It's a foregone conclusion that rates are going to rise with the consensus of investors expecting a 50 bp (basis point) hike. That expectation is already priced into the market. Most have lined up behind that notion leaving a scant few thinking that a 25 bp hike is the maximum increase now, followed by another in June. The latter group is being treated as though they are the last of the believers from "Church of the Flat Earth". Their reasoning is that the Fed generally operates in 25 bp increments and hasn't done a 50 bp hike since 1994. Unfortunately, there are signs of inflation in housing prices, wage increases and energy costs, which pretty much assures a 50 bp rate hike. Figuring this is nearly the Fed's last chance to hike rates prior to the November election, the consensus expects the Fed to make it count this time since the Fed will not want to take the blame for cratering the economy by meddling with rates later on. We fall into 50-bp hike camp too.
Enough about the background. What about tomorrow going forward? It really won't matter if the hike is 25 or 50 bp. Huh? Wouldn't a 25 bp hike create more uncertainty by leaving the door open for another hike on June 27, the next FOMC meeting, and crater the market tomorrow? That's one possible outcome. But in the bigger picture, what really matters is how the Fed views inflation GOING FORWARD. No matter what the value of the rate hike, Investor's reaction to the hike is really predicated how good a job the Fed does at minimizing interest rate fear and inflation uncertainty for the future.
If Alphonso the Great, in addition to a 50 bp hike says something like "today's action may not eliminate the need for future rate hikes" or "we are prepared to act decisively to keep the destructive forces of inflation in check, blah, blah, blah. . .", we may not see as much of a rally as we hoped for since that would mean that more hikes are not only possible, but likely. While we aren't predicting it, it is also possible that that kind of language could induce disappointed sellers back into the fray, sparking another decline, despite the 50-bp hike. We don't want to think too much about that scenario.
On the other hand, if the Fed's outlook is that "wages are rising, but under control, energy prices appear stable, and productivity gains are exceeding our wildest expectations", then another rate hike in June is less likely to occur and would give the markets the green flag to rally. In this more likely scenario, we'd expect the see the greatest interest in high quality issues, like chips, chip equipment, networking/telecom equipment, and the biggest cap B2B infrastructure/commerce issues. This action would likely attract momentum players back into some tier-two issues.
Not many have mentioned the wild card, the CPI numbers, which come out tomorrow morning at 8:30 ET. The expectation is for a 0.1% increase in the CPI, with a core rate increase of 0.2%. If it gets much beyond that to the upside, the rally most traders are looking for will likely turn to dust since a large CPI number would put investors on notice to expect further hikes. That's just a "what if", and another minefield to dodge. If it's a non- event, look for CPI news to quickly fade from the radar screen.
Let's take a look at the action in today's market to gauge the sentiment. Can you say "low volume"? Sure, after 30 days of it, we knew you could. While we like to see gains on the indices, this low volume stuff does not inspire confidence for any breakout of the trading ranges anytime soon. All that may change tomorrow if the Fed provides some future visibility. But we've learned not to count on Greenspan for clarity. The point is that trading volume is going to be the key for reversing the trend.
Volume aside, the Dow had a great day tacking on 198 points to close at 10,801. After the open at 10,606, the ascent was steady thanks to strength in a few key issues. MO got a big boost (+3.06, 27.38) from Goldman's and Morgan Stanley's favorable comments this morning that MO is undervalued. Financials like GE (+1.75, 54.00), AXP (+1.94, 52.19), JPM (+1.50, 132.00), and C (+2.69, 62.88) led the charge for the advance, while surprisingly, HWP (-2.19, 129.38) provided the biggest drag. Manufacturers including AA (+2.66, 67.88), GM (+1.43, 86.44), and MMM (+1.06, 85.94) all did heavy pulling too. Internals were decidedly positive with 1757 advancers beating out 1140 decliners, while up volume trumped down volume by more than 3 to 1. While this all looks good, not enough believers are putting their money where their mouths are as evidenced by the scrawny 851 mln shares traded. We won't be convinced the market is ready for a leg up until we see the volume return.
Does the market cause you to have trouble sleeping? NASDAQ was so quiet, Sprint could have done a "pin-drop" commercial today. Only 1.16 bln shares traded hands today, the lowest volume this year. Nonetheless, internals were good with advancers leading decliners here too, 7 to 6. Up volume led down volume by a factor of 2.5. In the end, NASDAQ gained 78 points to close at 3607, slightly above historical support of 3600 and mercifully back over the 200-dma of 3594, which should also provide support going forward as long as there are no CPI or Fed surprises. The next resistance is at 3750, so there's room to run.
Before we wrap it up, let's touch on a few of news items. First, there's a food fight breaking out over Nabisco (NGH), 80% owner of Nabisco Foods (NA). NGH is the deal, but carries tobacco liability, while NA trades at a higher multiple but has no potential tobacco liability. Carl Ichan already owns 10% of NGH, but "significant" interest is coming from a French food conglomerate. MO and RJR (Nabisco's former sister company) are also reported to be interested. No numbers available yet.
On the tech front, CA (Computer Associates) put to rest the negative speculation of an earnings miss by announcing earnings today of $1.13, in-line with estimates. Recall that their earnings postponement last week sparked talk and a price hit based on fear of an earnings miss. Not so, they just need more time, thanks to changing auditors.
Ciena (CIEN), who reports earnings on May 18th was added to DLJ's focus list, replacing Young and Rubicam (YNR). CIEN was up $4.19 on the news.
Next, Wit Capital (WITC) will acquire E*Trade's E*OFFERING unit. EGRP shareholders will get 25% of WITC equity and Wit's retail brokerage business, while Wit will become the exclusive source of IPO's, secondaries, and other investment banking services. Both were up over $1 today.
One tidbit we found interesting was a news item this morning that according to DLJ, DRAM prices in the Asian spot market fell $0.10 to $6.20. They cited that demand was weak, and dealers are looking to turn over inventory at cost. Perhaps that's why we saw the semiconductors gasping for air throughout most of the trading day until a nearly 50 point spurt in the last hour and a half of trading today.
Finally, just when you thought "old world" stocks were again losing their luster, especially metal stocks, fourteen of the world's largest mining and metal stocks including AL, NEM, ABX, N, AA, and PD are creating a B2B exchange of their own to cut the industries estimated $200 bln procurement bill. At 10% savings, that's $20 bln of newfound profits. Gold stock fever anyone?
OK, let's wrap it up. While we appreciate a good rally as much as the next guy (or gal), without volume it doesn't mean much and won't get us out of the trading range. We're at support on the NASDAQ and have another 100 points to go on the Dow until it hits resistance at 10,900, which we expect to hold unless volume picks up for a breakout. The only way that will happen is if Greenspan provides forward visibility after the rate hike. Some of that speculation could be removed on lack of surprise in the CPI numbers tomorrow before the open. But the Fed meeting outlook is the focus. The amount, 25 or 50 bp almost doesn't matter. Our job is to listen for how the Fed views the future. That will be the key. If the status quo is met, expect a trading rally at a minimum. If it's better than that, and volume picks up substantially (like over 2 bln shares on the NASDAQ), we would have much more confidence in a sustained rally. Helping matters, but overlooked is that this is also options expiration week, which could offer some upward bias.
Dust off your running shoes and get prepared to find new cheese (see January 24th, 2000 Market Wrap). Confirm the market direction, and as Jim says, don't buy too soon.