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Market Wrap

Is The Fed Still Our Friend?

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         WE 5-11          WE 5-4          WE 4-27          WE 4-20
DOW    10821.31 -129.93 10951.24 +141.19 10810.05 +230.20  +452.91
Nasdaq  2107.43 - 84.10  2191.53 +115.85  2075.68 - 87.73  +201.98
S&P-100  645.43 - 13.31   658.74 +  9.63   649.11 +  5.45  + 35.89
S&P-500 1245.67 - 20.94  1266.61 + 13.56  1253.05 - 10.07  + 60.41
W5000  11491.34 -195.93 11687.27 +178.43 11508.84 + 99.07  +557.12
RUT      487.36 -  5.53   492.89 +  8.92   483.97 + 17.26  + 11.69
TRAN    2879.56 + 10.37  2869.19 +  6.82  2862.37 +  1.07  + 94.71
VIX       27.48 -   .24    27.72 -   .05    27.77 -  1.24  -  1.27
Put/Call    .63              .67              .48              .91

This week was not nearly as pleasant as the prior week with the Dow losing -129 and the Nasdaq -84. We came so close to a potential breakout but the cards were stacked against us. With each economic report our hand of stud poker just got worse. You know how that works. It is like starting out with a pair of jacks and thinking alright, full house here we come. Instead every remaining card drawn is not even remotely related. The economic cards we drew this week have left traders wondering if the Fed will even cut at all, much less by 50 basis points. With 50 points already priced into the markets there was nothing left for traders to do but take profits and hope for a wild card on Tuesday.

The trio of economic reports on Friday painted a picture that was economically positive but two were Fed negative. Starting with the Retail Sales report which followed the same path as the Chain Store Sales on Thursday. Sales increased +.8% which was substantially better than the 0.1% estimates. Auto sales were up a full percent. The consumer is still buying and showing no signs of recessionary caution or worry about their jobs.

The PPI was benign at 0.3% vs estimates of 0.4%. Prices rose only moderately and showed that inflationary pressures were still absent from the economy. The entire last year has had very little indication of any inflation. About the only increases were in the energy prices and in products impacted by high energy. This was good for the Fed because they do not have to worry about inflation.

The preliminary reading of the Michigan consumer sentiment index for May came in at 92.6 compared to April's 88.4 level. Optimism about the economy appears to have rebounded and that is in marked conflict with expectations. With signs that maybe the economy has turned the corner and is recovering nicely the reasons for the Fed to cut rates aggressively have evaporated. The rebound in the stock market may have spurred the recovery in consumer confidence just at the wrong time. The Fed had said they were very concerned in the falling consumer confidence and it was obvious that Greenspan timed the last inter-meeting rate cut to juice the market as much as possible. Maybe his technique was too successful and now he is going to find himself back behind the curve of having cut too much too fast and he may need to take some back quickly. He just can't seem to get the right interest rate at the right time.

Traders were almost in shock at the abrupt change in events in just one week. Earlier in the week Fed funds futures indicated an over 90% chance of a 50 point cut next Tuesday. Out of nowhere a combination of events evolved to show that the Fed was ahead of the recession curve and had maybe acted too aggressively. As the chances for a big cut fell with each passing tick traders who had profited from the rate cut rally headed for the exits.

The saving grace was it all occurred on VERY light volume. The Nasdaq posted only 1.4 billion shares and was the lightest volume day of the year. The NYSE only managed 896 million shares and it was also the lightest day of the year. It was simply a buyers strike more than a sellers rout. This produces a serious question of what will happen when the summer doldrums actually appear. Still with no volume we can draw no real conclusions from the trading day other than everyone is holding their breath until the FOMC decision. The worst thing we could see next week would be an increase in volume with the markets still trending down.

The stock news did nothing to increase the desire to buy stocks. Deutsche Banc said the Gartner Group is going to release a highly negative report on the E-procurement software industry. It was widely reported and began with questions about Oracle's pricing power. There are several rumors that ORCL is under pressure to severely discount their software or lose sales. This goes along with rumors that ORCL will release an earnings warning soon. The report said the stand alone E-procurement business in this sector will not exist in three years. The entire sector sold off with ARBA leading the list including ITWO, CMRC, EPNY, FMKT and PPRO. Ironically ORCL may benefit from the demise of the smaller companies as CEO Ellison says customers want an entire suite of software from one company instead of buying pieces from multiple providers. PSFT and SAP were cited with ORCL as the possible winners of the sector shakeup. This news caused a drop in the Internet sector in general even though the report was specific.

Merger news was about the only other stock specific news of note. American International Group agreed to acquire American General for $23 billion in stock. This creates a huge company since AIG is already the largest underwriter of commercial and industrial insurance in the U.S. and one of the worlds largest.

Merck said it was acquiring RSTA, a leading genomics research company for $620 million in stock. That was not the biggest news for MRK. They are also rumored to be considering another offer for Schering Plough (SGP). SGP was up almost +10% on the news but sold off later in the day as analysts talked down the deal.

Canadian Imperial Bank is reported to be in talks to acquire Ameritrade for up to $10. Considering the gains in AMTD lately it appears to be true. AMTD has risen from $5.27 to $8.56 in the last three weeks in almost a vertical climb. CIBC is the third largest bank in Canada and their rival, Toronto Dominion bought TD Waterhouse. Last month AMTD chairman Joe Rickets, who with his family owns 60% of the company said he was not against selling the company, for $20 a share. Looks like CIBC was listening but somebody folded on the price.

Bond yields have spiked in the last two days to levels not seen since last November. When the Fed comes to an end of a cutting cycle, yields tend to rise in advance and telegraph the event. You don't need much telegraphing after the Fed fund futures dropped to only a 42% chance of a 50 point rate cut next Tuesday. The real market illness today was simply a realization that the free rate cut ride may have drawn to a close. With analysts now predicting only a 25 point cut on Tuesday and, are you ready, possibly the next move after that a rate increase, the climate for stocks has changed completely.

We all know the rules that say a rate change is not really felt in the economy until six months after it is enacted. We have several rate cuts that have not yet filtered through the economy and those cuts should help the economy over the next several months. The second guessers are saying now that Greenspan should stop now and wait for evidence of direction before changing rates again. However, not everyone has fallen off the 50 point wagon. 23 of 24 bond dealers surveyed on Friday said they still expected one more 50 point cut. Were they just uninformed of the day's events or just trying to put pressure on Greenspan to follow through on the expected cut to avoid a market massacre? Who knows but you can bet the discussions at the FOMC meeting on Tuesday will not be casual.

The Fed normally telegraphs their intentions the three weeks prior to the meeting and the fedspeak over the last three weeks has been minimal at best. They have given no direction and with the market expecting 50 points they are definitely aware of how consumer confidence could be broken by a plunging market if they do not cut. But, they may be convinced that a 25 point cut will keep the major carnage from occurring and a minor dip worth the risk.

Either way the markets are not going to be testing new upward resistance on Monday and Tuesday. Even if we do get another 50 point cut the market knows it is probably the last. The guidance the Fed gives with their decision will be critical to market direction over the summer. If traders feel the cuts are over and priced in then they have to depend on improved earnings to increase stock prices. That news is simply not here yet. Even the IBM pep talk on Wednesday was ignored by the markets and analysts even talked down their comments significantly causing IBM to gap down at the open. Has the ignore bad news and celebrate good sentiment from last week disappeared? If it has then next week could be rocky.

The semiconductor sector will brace for another blow when AMAT announces results on Tuesday. With the dueling chip analysts split over the fate of chip stocks this release could fuel the rally or douse the fires completely. Also on Tuesday Dell, BRCD and NTAP announce results. Dell has already said it would meet the lowered target but further guidance will be critical. They announced they were cutting more jobs this week and analysts will want to see what they say about future visibility.

Both the Dow and Nasdaq rallied into the close on short covering but no real buying interest. Traders enjoying the warmer weather called in "well" and took an early vacation day. The Dow fell at 10:AM when the consumer confidence was released but then traded in a very narrow 50 point range the rest of the day. 10800 was weak support but without volume you have no directional confirmation. The Nasdaq continued the slide from Thursday but the rate of descent slowed as it approached 2100. The broader markets as evidenced by the S&P stopped on support at 1240 dating back to mid-April. Again, there are no conclusions to be drawn here without volume and a Fed decision.

Waiting to exhale.

Traders should be wary of Monday/Tuesday. The Fed decision at 2:PM on Tuesday will be guessed and second guessed hundreds of times before and after it is announced. All this information will be sifted by traders and it will boil down to whether investors feel there is substantial risk at this level. If they decide the risk is minimal then they will continue to scale into the market and provide a base to build from. The key is the prior Fed rate cuts. As the economy improves due to those cuts, earnings will improve. The market will normally anticipate that event by about six months. Ding! That was the starting bell because we are at that point now. Don't jump in just yet however!

Could there be another retest of the April lows? Sure, anything is possible but I don't think it is probable. We are more likely going to be range bound once the post Fed volatility passes. If there is going to be a dip it should be soon and I would look at it as a buying opportunity for fall. The concept of buying the dip for fall is as alien to me as ET and I think most of our readers feel the same. We want action now, not later. Our task will be to find the leaders early. Find the stocks that funds are trying to sneak into for the fall and ride their coat tails for the short term. The best possible scenario would be a significant drop immediately. We could track the stocks that drop the least and they will likely be the leaders when money starts flowing again. So if the market crumbles after the Fed announcement we should all be cheering from the sidelines. Investing in the market is still the new national pastime and unlike the XFL it will still be here next year!

Technically the markets look terrible and ripe for that drop. The Nasdaq, S&P and Dow have all bounced off significant overhead resistance for two weeks with no breakthrough. The S&P-500 has clearly rolled over. The Nasdaq barely clung to weak support at 2100 at the close and should that fail, 2000 is almost a given. The Dow is now almost -200 points below its highs from early in the week and not showing any signs of life. If the markets get any bad Fed news this week it is a good possibility the shorts will come out in force again and we could easily get the retest the technicians have been missing since April 4th. Like I said earlier, I doubt we will retest the lows again but we could easily see 1800-1900 on the Nasdaq and 10300-10500 on the Dow. It all depends on the Fed and the guidance they give with their decision.

The "Capturing Stock Appreciation With Leap Puts" seminar for this Sunday was rescheduled to Sunday May-20th due to the Mothers Day conflict. We had numerous complaints that we would schedule this without thinking about the family strife it would cause. SORRY GUYS!!! We apologize! Click here for current info:

http://www.premierinvestorseminars.com/

Trade smart, enter passively, exit aggressively!

Jim Brown
Editor
www.OptionInvestor.com

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