The Federal Reserve lowered its target for the federal funds rate to 4 percent Tuesday afternoon. And hinted towards continued easings. In conjunction with its decision on rates, the Federal Open Market Committee (FOMC) released the following: "The Committee continues to believe that against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future." From the preceding comment, we can derive that the Fed is still on our team.
The Fed's decision Tuesday solidifies, in my mind, that they are doing everything they can to stimulate the economy and the stock market. I think Greenspan and his cohorts will cut by another 25 or 50 basis points in this cycle of benign monetary policy, taking the federal funds rate below 4.00 percent - 4.00 percent is the lowest the fed funds rate has been in seven years. I think it's also worth noting that with the exception of the Great Depression, the U.S. economy AND stock market have rallied EVERY time the Fed has cut rates five consecutive times - Tuesday's cut marks its fifth in this cycle.
But, despite the Fed's delivery of a 50 basis point cut and expressing its willingness to continue to cut rates Tuesday, the major market averages didn't respond in bullish fashion. So, what gives?
I think the market's reaction to the Fed's official announcement Tuesday is a microcosm for the intermediate-term. While I'm bullish over that time period, especially on cyclical and financial stocks, I think the trading is going to be slow, instead of the volatile moves we've grown accustomed to over the last several years - as traders, we'll need to grow patient! Of course, summer is nearing and this time of year has historically been slow. But, to emphasize my point, we simply need to examine the trading range of the Dow Jones Industrial Average (INDU) Tuesday. The Dow traded in a 100 point range, which is quite tight in light of the Fed's announcement. The Dow did briefly spike over the 10,900 near-term resistance level at the peak of the post-Fed buying spree, but pulled back during the final hour of trading. Going forward, I'll continue to monitor 10,900 as near-term resistance and just below, I'll be watching 10,800 as near-term support.
On a quick side note, I received a lot of questions concerning my chart in the Market Wrap column Monday about the Dow pulling back to roughly 10,500 and completing its inverse head-and- shoulders. Although I don't foresee the Dow pulling back to 10,500 in the near-term, I've illustrated on the Daily chart below the implications of such a move. In short, I think a Dow around 10,500 is a gift at this point in the cycle and would provide traders and investors an excellent, low-risk entry into the blue chip stocks within the Dow.
Of course, with the Dow, we're all still looking for the old economy index to breakout above 11,000. Two sectors that will need to participate if the Dow is to settle above 11,000 are the banks and cyclicals. Here's where it gets interesting. I've observed that the KBW Bank Sector Index (BKX.X) and the Morgan Stanley Cyclical Index (CYC.X) are on the verge of breaking out BIG TIME.
The Bank Sector Index has been biding its time below the 900 level for quite some time, en route to building a bullish wedge and continues to find buyers at its 200-dma, now at 870.
Meanwhile, the Cyclical Index has been contained by a descending trend line, which began way back in early 1999. The Cyclical Index is currently testing its descending trend line, now at 550, and an advance above 560 might confirm any breakout attempt.
If the Bank Sector and Cyclical Indexes breakout above the aforementioned resistance levels, then I think the Dow will see the upside of the 11,000 level. It may take several days, weeks or even another two months, but I foresee a breakout in all three before too long and feel that the it can be traded.
While I am bullish on the cyclical and financial sectors of the market, I'm still a little wary of the broader technology sector, although certain spaces are beginning to improve. For example, Brocade Communications (NASDAQ:BRCD) reported after the bell Tuesday that it was beginning to see an improvement in its business. Brocade is a maker of storage area networking solutions, and is a major player in the data storage market, along with EMC (NYSE:EMC), Veritas (NASDAQ:VRTS) and Network Appliance (NASDAQ:NTAP). Network Appliance also reported earnings Tuesday after the bell and made comments consistent with those from Brocade. Officials from both companies proclaimed that the bottom was in place in their respective business lines.
In addition to the reports from Brocade and Network Appliance, Applied Materials (NASDAQ:AMAT) delivered numbers that missed consensus estimates by one penny. Although Applied Materials missed its number, during the conference call its CEO, James Morgan, said, "I believe that we are now in the bottom of this cycle and we are waiting for the tipping point." While the magic word 'Bottom' was whispered, Amat has not yet seen an upturn in business, which epitomizes why I'm still somewhat cautious on technology shares.
For its part, the Nasdaq Composite (COMPX) rolled over following the Fed's announcement and closed below the 2100 support level. With the Nasdaq, the best game in town recently has been fading the market. That is, buying near support levels and selling near resistance levels, instead of chasing momentum-based moves that lead to head-fakes and whipsaws. With an increasing number of companies mentioning the bottom word, but not yet raising guidance, it makes sense that the Nasdaq could continue to trade sideways during the summer months or until the tech business improves.
(For those traders who monitor the semiconductor sector closely, and particularly its impact on the broader tech sector, it's worth noting that the Philly Semi Index (SOX.X) closed just above key support at the 600 level.)
I'd like to reiterate that instead of aggressively pursuing stocks either on breakouts or break downs (momentum trading), I think it may become conducive to fade the prevailing trend. Again, that means buying near support and selling near resistance, especially in the tech sector.
With the Fed's meeting out of the way, and not another scheduled until late June, the market will be left with earnings news and guidance in addition to economic news for catalysts. We have several more big earnings reports this week from the likes of Hewlett-Packard (NYSE:HWP), Dell Computer (NASDAQ:DELL) and CIENA (NASDAQ:CIEN), which have the potential to move the markets.
For the most part, I'm growing more bullish over the intermediate-term and strongly believe that the markets have the potential to advance substantially in the latter part of the summer and into the fall. In the meantime, I think it makes sense to stick with the blue chip names of the market, which continue to work higher, such as the cyclicals like Boeing (NYSE:BA), Caterpillar (NYSE:CAT) and DuPont (NYSE:DD) - a Jeff Bailey favorite!