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Market Wrap

Fed Raising Rates

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      05-04-2004           High     Low     Volume   Adv/Dcl
DJIA    10371.20 +  3.20 10386.04 10266.17 2.01 bln 1869/1377
NASDAQ   1950.48 + 11.80  1968.70  1933.60 1.87 bln 1855/1266
S&P 100   547.15 +  1.30   551.03   543.59   Totals 3724/2643
S&P 500  1119.51 +  2.02  1127.65  1112.89 
W5000    Problem with data feed
SOX       448.31 +  7.40   454.76   440.87
RUS 2000  569.64 +  4.16   575.18   565.18
DJ TRANS 2915.63 -  7.50  2935.02  2902.28   
VIX        16.55 -  0.07    17.13    15.97
VXO (VIX-O)16.36 -  0.27    17.52    15.88
VXN        25.14 -  0.58    25.89    24.36 
Total Volume 4,245M
Total UpVol  2,767M
Total DnVol  1,362M
Total Adv  4247
Total Dcl  2978
52wk Highs  134
52wk Lows   224
TRIN       0.87
NAZTRIN    0.69
PUT/CALL   0.67

Using Fedspeak Greenspan said they were ready to raise rates but they are not raising them now. The Fed left rates unchanged but said they could begin raising rates at a measured pace in the near future. The market was not sure if they liked the new Fed policy stance despite getting everything they wanted from the statement.

Dow Chart - Daily

Nasdaq Chart - Daily

The morning started off great with Chain Store Sales jumping to +1.5% for last week compared to -0.5% for the prior week. No real excitement there with tax refunds fueling the buying. The real excitement came from the Factory Orders, which soared +4.3% for March compared to +1.1% for Feb. That Feb number was revised up from only +0.3%. Consensus for March was only +2.3% and it was widely assumed to be optimistic. The blowout at almost twice what was thought to be optimistic really gave traders some positive economic ammo but they failed to hold any morning gains. Nondurable goods rose +3.5% which completely erased the -1.8% decline in February. Shipments rose +3.8%, unfilled orders rose +1.2% but most important was nondefense capital goods, that is normal business equipment, rose +4.5%.

The upward revision to a weak February and the blowout in March suggests the economy may actually be exploding. While traders were excited with the initial release their fears that the strong numbers would excite the Fed weighed on the bulls. The morning bounce to 10330 on the news was sold into the pre Fed lull. Worry, worry everywhere and not a buy program in sight.

Helping fan the economic flames was a very minor +6.1% jump in layoffs from 68K to 72K in April according to the Challenger Layoff report. Better news showed that the private sector was firming and the government sector was responsible for the majority of the cuts. The number of layoffs has been moving steadily down for months with only a couple spikes in Oct and Jan. Challenger also found that small business hiring actually grew +25% in the first quarter. Companies of less than 500 employees are doing the most hiring.

The big news was of course the Fed announcement that they were not going to raise rates today BUT they are ready to raise rates at a pace that is likely to be measured. (Their words) They cleaned up their policy statement to remove any hint of economic weakness and any reluctance to act on their part. The dumped the comments that either "inflation" or "unwelcome disinflation" were likely and adopted a "risks are equally balanced" posture. This was a key point they tried to make. No inflation. The mentioned inflation in one form or another several times. "Long term inflation expectations appear to have remained well contained." "Price stability is in balance." "Inflation low and resource use slack." All of these comments were made to tell us that the Fed is not worried and not in a rush to raise rates. When they do begin to raise rates it will be at a "measured pace" meaning they are not going to try and shock the market or make any large sudden moves. It was a picture of a Fed trying to be patient in an election year without actually saying so. In Fedspeak it is all "read between the lines".

They have left us with an economy that is "robustly growing productivity", "output expanding at a solid rate" and "hiring appears to have picked up", all their words. They like what they see and see no reason to raise rates despite the lowest rates in decades. The markets rallied to new highs for the week on the news then crashed back to pre Fed announcement levels. The Dow ended up +3 and the Nasdaq +11. What in earth happened?

Fear of the unknown. The Fed left the cloud over the market and left traders guessing about when the rate hikes would begin. There was actually a strong contingent of traders hoping for a hike today. Traders in the Chicago pits and on the floor of the NYSE booed when the announcement was made. Amazing when you think about it. The Fed statement gave everyone a present, strong economy, no inflation and no rate hikes on the horizon. If the market was afraid of rate hikes last week then today should have been a breath of fresh air. Unfortunately it did not give them any view of the future other than the Fed is ready to act if needed. That can happen as soon as next Monday or six months from now. It is like riding down the highway with a bubble on your tire. You know it could pop at any time and you are afraid to go very fast. That is the market today. We have a Fed cloud over our car and lightning could strike at any time.

The outlook shifted to events in the future that could cause the Fed to react. The immediate threat is the Jobs report on Friday. The Fed has been known to react between meetings on the Monday after an employment report. If the Layoff report is any clue then the Jobs report this Friday could be decent. The +25% growth in small business hiring as indicated by Challenger is the key. Last months report showed an increase of +308,000 jobs and a similar report this month would just about guarantee a rate move in June if not before. Should the jobs from last month be revised down significantly it could put the Fed on hold that much longer. It is a very confusing scenario for institutions and for bond traders. When confusion reigns nothing happens. That is exactly what we saw today.

The Dow had been uptrending slightly from last weeks severe depression. The post Fed spike sent the Dow to near 10400 once again but that level was very short lived and we fell to close back near 10300. The slight uptrend is still intact but just barely. Resistance is still 10325 and it has held for three days. Support is 10265 and it has held for two days. Odds are good we are going to break one of those levels on Wednesday.

The Nasdaq is exhibiting the same very slight uptick although it was the strongest index today. We saw a spike to 1970 after the announcement, a solid retrace of those gains but a stubborn hold at 1950 at the close. After three days of concentrated selling last week the Nasdaq is refusing to give ground. Current support has turned into 1933 and that is also the 200dma as we discussed last weekend. It is right on the edge of a real rebound or a real failure. The buyers appeared at the right level but so far have not been able to get enough traction to move it higher.

This brings us to the rest of the week. Just like we went into hold mode for the announcement today we could just as easily maintain this mode into the Jobs report on Friday. The Fed stance put the bulls back into bad news mode where they want any economic news to be just good enough to prove there is an economic pulse and not strong enough to require a Fed sedative. Instead of wanting another +300K of new jobs on Friday the bulls would be perfectly happy with a number less than consensus, say in the +150K range. Too much good news now could activate the Fed either at or before the June 29th meeting. The goal for traders now will be to somehow get through the June-29th meeting with no hike and that gives them a potential free pass into August. This makes everything that happens between now and the June FOMC meeting of greater than normal importance.

Personally I think the markets received a free pass until Fall as long as the jobs do not continue at the +300K pace. The Fed is clearly watching for inflation but not currently concerned due to the weakness of the recovery until now. The Fed does not want to crash the housing market before summer and they realize that the stock market also contributes to overall good will and economic prosperity. With everything running so smoothly AND with the bond market already pricing in a rate hike, the Fed only needs to keep up the tough talk and the credit markets will keep rates at a reasonable level. This will allow the carry traders plenty of time to unwind their trades and the home builders to produce a record summer. The economy will benefit from both and in an election year that can't be bad. Besides, if a little economic slowdown appears over the summer the Fed will not be making it worse. Now, all I need to do is make the market see it my way.

For Wednesday I would look to be long over 10330/1960 and short under 10275/1940 and simply follow what the market gives us. The funds could begin to reenter the market tomorrow but remember we are still in a down trend. Until the pattern of lower highs is broken we are just range bound at a lower level with risk to the downside. Earnings are still decent but declining in quality and frequency and the summer doldrums are just ahead. There is no real catalyst to send us higher but there is no specific risk either. The Fed should already be priced into the market. We are likely to see some volatility at the open as the various forces do battle so don't look for direction until after 10:00.

Enter Passively, Exit Aggressively.

Jim Brown


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