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Market Wrap

Measured Pace For Inflation

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Measured Pace For Inflation

The Fed minutes for the March meeting were released at 2:PM and the party started almost immediately. In brief the Fed members felt that an accelerated pace of rate hikes did not appear necessary at this time. Inflation pressures have picked up in recent months but still remained under control. The Dow was down -81 at the time and Nasdaq down -20 but those losses were quickly erased as traders bought stocks and shorts got squeezed.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The morning started off ugly with the U.S. trade deficit jumping to -$61 billion and an all time high for February. January's deficit was also revised upward to $58.5B. The trade deficit with China narrowed to $13.8B from $15.3B but the jump in oil prices offset that decline. Oil imports grew to $13.3B from $11.9B in January. The U.S. has trade deficits with China, Japan, Brazil, Korea, Taiwan and Canada. Imports rose 16.8% over the same period last year with exports rising only 8.7%.

The record trade deficit pushed equities over the cliff and the Dow fell -81 points to 10360 by mid afternoon and the release of the FOMC minutes. Those minutes were expected to be bearish in view of recent inflation numbers and slowing growth. Most analysts had expected some stronger language about the future pace of rate hikes. The minutes showed the Fed was concerned about inflation but felt it was under control. The committee also repeated its current status by saying removal of the rate accommodation could continue at a measured pace. Traders immediately seized on this as confirmation that there would be no 50-point hikes in our future. However, there were plenty of points to worry about. Participants said "uncertainty about the intensity of inflation pressures had risen in response to recent developments and possible inflation outcomes were tilted to the upside." They also addressed the "measured pace" language. "Some participants expressed the view that such language could constrain future policy inappropriately as the odds that the committee might need to step up the pace of policy firming were thought to have increased." Some members felt, "measured" ought to be removed not only because it limits policy action including a pause or more aggressive tightening, but also because some members felt the odds of a 50-basis point tightening had increased."

The key point in the minutes was this language, "although the required amount of cumulative tightening may have increased members noted that an accelerated pace of policy tightening did not appear necessary at this time." Pimco's Bill Gross said this completely erased the potential for a 50-point hike for at least the next three meetings. He felt as long as the measured pace language remains it would take at least two meetings to remove it and change their bias to a more aggressive stance. Also, the current top for the Fed is thought to be 3.5%, up 75 points from our current 2.75% rate. That takes care of the May, June and August meetings and puts us near the fourth quarter before there is any major change in policy.

The release of these minutes was feared by traders after the apparent accelerated concern for inflation as expressed by several Fed heads over the last couple weeks. There was a strong fear that the minutes would suggest a coming removal of the measured pace language and an acceleration of the rate hike process. This thought process had pushed Dow and Nasdaq to their lows for the year just before 2:PM. The surprisingly tame minutes sent bonds soaring with yields falling to a five week low. Oil, down -1.00 at the time of the announcement fell another buck to $51.80 as money fled oil and headed for equities. The Dow rebounded from 10360 to 10529 in about 45 min. This was a 169 point reversal and a stunning change in fortunes. However, much post event analysis suggests the spike could be in trouble.

In the countless post event interviews there were numerous analysts that did not see any change in Fed position. The Fed is still on track to raise at least three more times and the committee discussed removing the "measured pace" statement. Nothing really new here but you would have thought the markets had seen something written in invisible ink. In reality it was a classic "sell the rumor, buy the news" reaction. Bears were leaning heavily on the market this week after four days of gains last week. We had completely retraced all the gains and returned to the lows for the year once again. Traders expected the worst from the minutes and were seriously short in expectations of a support failure at 10360. When the minutes failed to live up to the bearish expectations the contingent of traders on the sidelines jumped in and shorts suddenly found themselves on the wrong side of the market. The afternoon spike was a picture perfect short squeeze.

The question now is of course will it hold? This is exactly the point in the earnings cycle where there is still enthusiasm for the coming guidance and there have not been enough disappointments to spoil the sentiment. We are also right back on the high end of our recent range (10360-10550) and nearing resistance once again. We have retraced this range several times now and time is running out. Economic reports increase in frequency and importance as the week progresses as do earnings. I would still be very careful about any long at this level.

There is a strong feeling we could be heading into a repeat of the summer from hell. That is what traders call the summer of 2004. Volume was very light, the markets were trendless and nobody made any money until October. With the Fed trying to suppress the economy and at least three more hikes ahead of us there is very little excitement about being in stocks until the Fed rests. This suggests this summer could easily be a repeat of 2004 or worse.

The wild card here is still oil prices. The sharp drop in oil prices at 2:PM as bonds and equities rallied clearly showed some sector rotation. Inventory levels are continuing to grow and Saudi Arabia is committed to pumping every barrel they can as we move into the driving season. Add in the normal Q2 demand slump and we should be seeing some lower prices. Oil has resisted breaking the $52.50 level as investors held on to their belief that the initial dip was just temporary. With the close at $51.80 tonight we could see some sell stops hit and finally get the real break we have been looking for. If oil does break lower those profits could be shifted to equities as earnings take center stage. That is a lot of "ifs" but I think you get the picture. $50 oil will be the key to watch. If $50 holds we could see that money come right back to energy stocks. If it breaks we could get a rush of cash back into equities as profit taking accelerates. I always think it is strange that half the market will be taking profits at $50 while the other half will be celebrating an entry point at $50. Those differing views are what makes a market and produces profits for us all.

Oil Chart - Daily

SOX Chart - Daily

Russell 2000 Chart - Daily

The earnings parade is finding it more difficult to dodge the warnings left by the early reporters. I visualize the band members in a parade stepping around the manure piles left by horses in front of them. The piles of earnings manure are accumulating and the big horses have yet to appear. Foundry warned after the bell that earnings would fall well below prior estimates due to weak sales to North American business customers. Does that mean Cisco is also seeing weak sales? Software companies are still leading the parade and leaving droppings everywhere. Compuware warned after the close that earnings would be 6-8 cents and well below the 13 cents expected. They said more revenue was being deferred due to slower than expected acceptance of licenses. BMC Software and Computer Associates also warned. TZOO reported earnings that were below estimates. Revenue was up but so were expenses. There are more examples of earnings challenges but I believe you are getting the picture.

So far those who have reported have been only the pre-show and the main event begins next Tuesday with Intel, EMC, JNPR, LU, STX, SGI, SMDI, TER and YHOO to name a few. Notable earnings the rest of this week include several chip makers, AMD, ASML, LRCX on Wednesday along with Apple Computer. On Thursday we have FCS, RMBS and SUNW. I highlighted the chipmakers on purpose. The SOX finally broke support at 410 and dipped to 403 intraday today. It appeared the biggest supporter of the Nasdaq had finally cracked and a major plunge was just ahead. That dip reversed on the afternoon short covering to end back over 410 but it may only be temporary. Investors will begin to see some real earnings reports over the next week on chip stocks and without some positive guidance there is no future for techs. The book-to-bill at .78 is the backdrop and investors are holding the SOX at 410 hoping for positive news that we have seen the bottom. If those hopes are dashed by the first handful of chip earnings then the Nasdaq is in trouble.

Actually the Nasdaq is not the only index already in trouble. The Dow was slowly sinking with IBM, AIG and GM the primary anchors. The choppy markets have soured investor sentiment to the extent that Ameritrade saw volume drop -2% for the quarter and over 50,000 investors closed their accounts. According to AMTD this was the highest closure rate in over 10 quarters. Trading volume on Monday was barely 3.2B shares and the lightest trading day of the year. It was even lighter than the pre-holiday volume we have seen. Volume has been declining for a week to reach that level. Investors are just not seeing any reason to be in stocks as summer approaches. Retail investors remember the pain from last year and they would rather have a weekly root canal than suffer through the April-October 2004 period all over again.

Despite the rebound my outlook has not changed. I still believe resistance at 10550, 2020, 1195 will hold without a major catalyst to push them higher. Average earnings guidance will not do it and any high profile misses could pull the rug out from under those buyers still trying to force long trades. Even if we do breakout on some good news I would be skeptical of any gains. I would continue to be patient and focus on energy stocks. We are getting the Q2 drop in prices we have been expecting and rather than trying to chase tech stocks, banks, builders or cyclicals, the best plan is still energy. The 100-day average should be initial support and it is currently $49. That makes the psychological $50 level more likely to hold. The 200-day is $45 so plenty of near term support. I would start nibbling on positions at $50 and add to them on any dip under $50. That could be wishful thinking on my part but many times the profit taking can become quickly overdone and that would be an opportunity for me. Another build in inventory levels on Wednesday could push us to that $50 level. Just because the summer doldrums are ahead does not mean we can't be investors. Definitely, enter passively and exit aggressively.


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