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Market Wrap

No Real Surprise

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The Fed raised rates by 25 points for the 15th consecutive increase. No surprise in that event. The Fed also kept its language from the last meeting exactly the same. "The committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance." While that was the official "expected" language there was a considerable amount of speculation that the Fed would soften it to suggest an end to hikes at the next meeting. By retaining the current language Fed watchers now feel there is a rising chance of an additional rate hike in June. The Fed funds futures spiked again to price in about a 16% chance of two additional hikes. This may not be a high probability bet but before the Fed announcement the chances of an additional hike in June had slipped to nearly zero.

Dow Chart - 30 min

Nasdaq Chart - Daily

The Fed published a larger announcement than normal and this was the key paragraph for the bulls.

"The slowing of the growth of real GDP in the fourth quarter of 2005 seems largely to have reflected temporary or special factors. Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace. As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures."

If you translate this into English it reads like this. The economy slowed to a standstill in Q4 due to the hurricanes on the Gulf coast. The economy rebounded strongly in Q1 as a result of the rebuilding efforts and replacement of damaged goods in the area. The GDP for Q1 is likely to be over 5% due to this rebuilding/replacement cycle but that level will not be sustained. The Fed believes that growth will moderate to a more sustainable level in the 3.5%-4.0% range. However, while core inflation is currently well contained there are substantial risks to the upside. Specifically energy and commodity prices continue to produce concerns.

You should note in the official statement above that energy was mentioned twice in the same paragraph on a day when crude prices closed over $66. Natural gas prices for the December 2006 contract closed at $10.37, less than $2 below the 2005 contract high and more than +$3 over the highs seen in 2004. These prices for natural gas are even more amazing when you realize that gas storage levels are at +67% above the five-year average thanks to the warmest winter in decades. Clearly the Fed is concerned about the impact of these high energy prices on inflation and on the economy. The good news is the Fed thinks the economy is still growing strongly enough for them to continue raising rates.

The markets did not celebrate the Fed's positive view on the economy. The Dow plunged to 11147 and -104 intraday. The constant chatter on CNBC about the potential for two more hikes kept the pressure on the indexes and there was no material attempt to rally after the announcement. Normally the Fed announcement is met with a strong directional move that is reversed by the close of trading. We did not see that today.

The morning started out with a sharp spike in Consumer Confidence to 107.2 in March from an upwardly revised 102.7 in February. This was nearly a four-year high. Expectations increased +5.7 and present conditions by +3.0. Consumers felt the labor markets were improving and there were indications that those planning to buy homes increased. Concerns were given as rising interest rates, higher gasoline prices and increasing debt levels. Still this was a strong indicator for the bulls. Rising confidence means consumers have cash to spend and this is good for the markets.

Also bullish for the markets was Richmond Fed Manufacturing Survey. The headline number jumped to 21 in March from zero in February and negative readings for the prior two months. New orders jumped from 6 to 22 and the order backlog rose to -1 from -13. Shipments jumped to 26 from 2. These were positive numbers reflecting the current situation. However, the six-month outlook fell to 46 from 71 for -25 point drop. This suggests the index is still reflecting the Q1 rebound but the expectations mirror the Fed's outlook for slowing growth.

Wednesday is a blank for material economic reports but Thursday and Friday are loaded. Thursday has GDP, Help Wanted and the Kansas Fed Survey. Friday has Personal Income, NY-NAPM, Consumer Sentiment, Chicago PMI and Factory Orders. All of these reports are expected to show economic improvement. This should set the stage and provide fuel for any end of quarter window dressing.

With no earnings news on Tuesday and the majority of the chatter about the Fed we were left with energy as the only major sector with any gains. Diamond Offshore was the clear winner for the sector as it broke resistance at $84 and sprinted for a +5.45 gain to $87.87 and a new all time high. Pushing energy stocks higher was a +$1.90 surge in oil prices to more than $66. The breakout over resistance at $65.50 came on a variety of factors. There was a threat of a strike in Norway and a strike in progress in France. Oil loading in Iraq was halted by bad weather and militants were still active in Nigeria.

The biggest pressure to prices was a Wall Street Journal report that an oil ETF could begin trading as early as next week. This is expected to produce a huge surge in futures buying once the millions of retail traders are able to invest in oil futures as easily as buying shares of the QQQQ. We saw monster moves in the underlying commodity when the gold ETF began trading. The Streetracks Gold ETF (GLD) now controls over $6 billion of gold bullion. With the huge interest in oil and the coming Peak Oil problem the buying in an oil ETF is likely to be huge. We already have the S&P-500 Energy SPDR (XLE) and the Oil Service Holders (OIH) but nothing available for retail traders to actually trade crude. The American Stock Exchange is preparing to introduce the ETF on Monday, which will trade under the symbol USO. The exchange has yet to receive final regulatory approval but that is expected this week. The initial price will be the price of the current crude oil contract at the NYMEX exchange. This should be a major event in the oil sector and should boost the prices of oil companies with actual reserves more than drillers and service sector companies. All will benefit but those with real reserves and production should benefit from the upward pressure on crude oil prices. The advent of the ETF could actually provide some additional stability to the price of oil due to the large number of futures contracts expected to be controlled by the ETF managers, Victoria Bay Asset Management. This will also make it easier for mutual funds to play oil in a liquid investment vehicle just like they do with other sectors through existing iShares and ETFs.

May Crude Oil Chart - Daily

December Crude Oil Chart

Peter Thiel was on CNBC today making some interesting comments. Thiel sold PayPal to Ebay for $1.5 billion a couple years ago. He currently makes between $70-$100 million a year from his various investments. One of those investments is NOT a home. He feels so strongly that the housing bubble is going to burst that he sold his own home and is now renting. I have trouble understanding his concern. Since he could pay cash for any home he wanted, say a $5 million fixer-upper, it would only be pocket change for his current income level not to mention his huge investment holdings. Thiel says he expects home prices to fall -15% to -20% soon. Even using his -20% number that would only mean a -$1 million hit on the $5 million home I used as an example. If you are sitting on more than $2 billion in cash, stock and investments and make $100 million a year I commend him on his cautionary housing stance but I believe it is misplaced. But then I don't have $2 billion. Maybe that is how you gain it by cutting corners. A million here, a million there and pretty soon you have some real money. Thiel also warned about the coming energy crisis. He predicts oil prices will be in the $100-$150 range within the next five years. While I might not agree with his frugality in housing I do agree with his energy warning. Maybe this means I should sell my home and invest the proceeds in the new crude oil ETF. (grin)

The rise in oil prices on Tuesday did not depress the equity market. If anything it provided support for the market with nearly every energy stock posting gains. On Wednesday we get the weekly inventory numbers and analysts expect a build in crude of +1.3 mb but a drop in gasoline of -1.5 mb and a drop in distillates of -1.2 mb. Since a some of the gain today was due to geopolitical concerns we are at risk for a decline in prices on stronger than expected supplies. The geopolitical risk headlines typically have a short shelf life of about 24 hours. Unless there is additional news the political bounces are normally short lived. If crude declines then transports could recover and provide support to the broader market. The wildcard here is the oil ETF. Speculators trying to get into crude ahead of the start of trading on the USO could keep prices steady.


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Where are the markets going now? The Fed is behind us and the end of the quarter is just ahead. In theory nothing has changed from the market stance that got us to this level. The Fed was generally assumed to be targeting 5.0% and that is now guaranteed by today's statement. The economy was already assumed to be slowing from its Q1 rebound rate and the Fed statement simply agrees with that outlook. Inflation "remains contained" according to the Fed and that takes the pressure off the Fed to overshoot. I just don't see any material change in the outlook but then the markets failed to rebound out of the post Fed dip. Buy the rumor, sell the news appeared to be the game plan today.

We know from historical patterns that the day after a Fed meeting is down more often than not regardless of the Fed action. However there was no real rally ahead of the event and that should prevent any material reaction dip beyond what we saw after the announcement. If determining market direction were as simple as making a couple assumptions based on historical trends then we would already know which way to bet. However, market direction after a Fed meeting is never a sure thing and the market exists to humble as many speculators as possible.

With that said I am crawling out on that limb along with my bias for all to see. I believe the quarter end cash flow would normally trump the post Fed letdown. However, AMG Data reported that investors withdrew -$1.7 billion from mutual funds for the week ended Wednesday March-22nd. Trimtabs reported inflows the prior week of only +$1.5 billion compared to +$3.5 billion in the week before that. This paints a picture of decreasing cash flow for two consecutive weeks and that corresponds with the stall by the indexes at the current levels. For whatever reason it appears on the surface that investors are losing confidence in the markets after the early March rebound. We could be seeing some withdrawals for tax payments as the income tax deadline draws closer. We may also be seeing the early adopters from the sell in May and go away crowd. For whatever the reason the cash flow from retail investors appears to be slowing.

Russell 2000 Chart - Daily

This is not the same retirement cash we normally see flowing into funds at the end of quarter. Those retirement contributions are typically routine and not taxable. The bottom line: For the last two weeks I have been cautious about the markets after their stall at the new highs. Last Tuesday the indexes rallied sharply and then imploded into the close giving back all their gains and ending with big losses. I turned negative given the volume and the appearance of a climax spike. Buyers rushed in and the Nasdaq finally found traction and completed a four-day uptrend. Meanwhile the Dow and S&P moved sideways. Today's post Fed drop knocked the Dow back to 11150 and the S&P to 1293. Both were new two-week lows that came after lower highs. Normally this would produce a negative bias but the Nasdaq and Russell have failed to confirm. The Russell gave up only -2 points today after setting a new historic high. The Nasdaq failed again at resistance just under 2330 but rebounded on a touch of 2300. These two indexes are a better read of fund bias than the Dow and S&P. As long as funds are putting money into small caps and techs the rally should have legs. "Should" and "could" are the escape words for market pundits. I hate to use those tonight but it is nearly impossible to avoid it since nobody knows the market direction for sure. My bias tonight is for the end of quarter cash flow to offset any post Fed weakness and provide a positive trend for the rest of the week. Funds should take that cash and attempt to paint the tape to show the best results possible at quarter end. Positive results convince fund investors to let it ride and that is the goal for fund managers. I am expecting the dip to be bought and a return to the highs before Friday's close. Next week could be a problem with window undressing but we will deal with it when it comes. I cautioned on Sunday to "Sell too Soon" and those who took profits should be in great shape to buy the dip.

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