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Market Wrap

Bear Fur Flying

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Those bears short over the Fed announcement barely had time to blink before the wave of bullish euphoria blew past them with the suddenness of a nuclear shock wave. The bull stampede over the retreating bears was the biggest reaction to a Fed rate cut since April 2001. Nearly every sector saw monster gains on the completely unexpected Fed decision.

Dow Chart - Daily

Nasdaq Chart - Daily

Analysts had hoped the Fed would cut 50 and 50 but almost nobody actually expected it to happen. It was too good to be true and left commentators nearly speechless. In case you did not hear the news the Fed cut the Fed funds rate by 50 basis points and also cut the discount rate by another 50 points. That puts the Fed funds rate at 4.75% and the discount rate at 5.25%.

The Fed statement was also positive and that was the opposite of what you would expect by their actual move. Some comments from the Fed statement:

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Todays action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Developments in financial markets since the Committees last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.


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The key words there are "help forestall" and "might otherwise arise." That suggests the Fed did not feel the economy was in trouble or heading for a recession. It suggests the Fed was bowing to market sentiment to make a preemptive strike to head off further credit problems rather than react to problems that already exist. The statement also said economic growth remained moderate and readings on core inflation had improved modestly. There was nothing in the statement to indicate the economy was weakening. The Fed appeared willing to take a precautionary cut rather than wait until conditions worsened. This is completely contrary to most Fed moves in the past. Historically the Fed has always been behind the curve and analysts took today's action as evidence this Fed was going to be more proactive in dealing with economic issues.

This was the perfect scenario as far traders were concerned and the markets exploded higher with the Dow adding +335 points. Earlier in the day we saw that producer prices (PPI) for finished goods fell by -1.4% in August and that was even more reason for the Fed not to be worried about inflation. The core rate for finished goods rose only +0.2% and right inline with expectations. The inflation rates as seen in the PPI gave the Fed no reason to remain on the sidelines. However, the PPI numbers were low mostly because of the -6.6% drop in energy products in August and that drop is likely to be completely erased in September.

Chain store sales, a measure of consumer confidence, fell -1.1% for the prior week with the index falling to 480.3 and a level not seen since June-30th. This was the sharpest decline in four months. This suggests the back to school buying cycle is over. With gasoline prices spiking sharply over the last two weeks consumers may start closing their wallets to anything but necessary spending.

The National Association of Home Builders (NAHB) reported that the NAHB Index fell to 20 for the first two weeks of September and that is the lowest level since early 1991. The new home sector continues to decline with buyer traffic almost nil. The market for new homes is nearly dead. If you adjust for seasonality the September numbers are the lowest on record for every subcategory. Builder optimism is the lowest on record for the 22 years since the index was created. The lack of financing for anyone other than prime credits and the closing of many jumbo loan outlets (loans over $417,000) has taken many homes off the market. Standard Pacific said they were seeing increased traffic at a fire sale that began on Friday that copied Hovnanian's (HOV) "Deal of the Century" sale last weekend. Ara Hovnanian said on a webcast today that sales last weekend jumped 10 times the recent pace because of their drastic 3-day price cut sale. Prices were slashed $75-100K to get as many homes as possible priced below the $417,000 jumbo loan threshold. The Fed rate cut should help homebuyers more from a sentiment standpoint than an actual drop in mortgage rates. Since the Fed rarely stops at one cut it suggests rates will continue lower at least through year-end.

Helping the markets prior to the Fed announcement was better than expected news from Lehman. Lehman posted earnings that beat the street by +7 cents and said the worst was over for the credit industry. They took a write down of $1 billion on their $27 billion in leveraged loans but that was far less than most analysts expected. Lehman said they had losses in their mortgage division but hedges put in place to protect against declines had eliminated all but $700 million of the losses. All but $700 million? That seems like a lot of money to me but when you deal in the tens of billions I guess that is a minor loss compared to what it could have been. Overall they still earned nearly a billion dollars for the quarter despite the mortgage losses. Lehman said they lowered their valuations on debt to 92 cents on the dollar to reflect the new paradigm in the credit markets. This was also less of a charge than most were expecting. Lehman said strong trading profits and investment banking results offset the losses in the mortgage business. Lehman said it had the second best quarter ever for its equities business. LEH spiked +$5.87 or +10% on the news. Other earnings reporters for the week include Morgan Stanley +3.60, reports on Wednesday, BSC +3.82 and GS +12.89 both report on Thursday. Obviously all were also helped by the rally in financials after the Fed announcement.

Lehman Chart - Daily

I have been recommending Goldman as a buy in my commentaries for a couple weeks and it has rebounded from $180 to just over $200 during that period. I continue to believe that Goldman will beat estimates on Thursday and could easily return to new highs very soon. Bear Stearns has risen to the top of the congestion range where it has been trading for the last 6-weeks to stop right at $120 today. Bear is widely believed to have the worst earnings of the group but a better than expected report could easily put them on a path higher.

E*trade Financial (ETFC) rebounded to shake off news that earnings for the year could fall as much as 25%. E*trade said it was exiting the mortgage business and that could knock as much as 48 cents (-$32 million) off their full year earnings. E*trade has a $30 billion portfolio of mortgage loans that it will sell over the next 18-24 months in order to focus only on its trading business. Pretty soon if you want a mortgage you will have to go to Countrywide or Wells Fargo as the only major players left.

Gold rose to a 28-year high just over $735 as the dollar fell after the Fed announcement. The previous recent high was $732 set on May 12th 2006. Today was the highest price for the front month contract since Feb-11th 1980. The dollar collapsed even further on the prospect of lower rates, falling another half percent. The falling dollar also spiked the price of oil to a new record high at $82.38 after the Fed announcement. This is even more amazing since the crude contract expires on Wednesday. This is a prime example of a momentum play gone bad for the bears. Shorts are jumping on every new high in record numbers only to have some news event blow them out again.

Dollar Index Chart - Weekly

October Crude Futures Chart - 90 min

Late after the market closed there were a flurry of comments from some analysts trying to second-guess the Fed's move. The prevailing commentary was along the lines of "what to they know that we don't?" It was out of character for the Fed to make such a major move, especially after they said they were more concerned about inflation at the August 7th FOMC meeting. We have seen other commentators suggesting that the August Jobs number was a reporting problem not an actual jobs problem. The Fed should have investigated this and their move today suggests it may have been a real loss of jobs. We may never know what really pushed the Fed to react so strongly but the markets are not complaining.

The Dow completely blew away the resistance at 13500 and even closed over the next resistance level at 13700 leaving only the prior historic high at 14021 as a milestone to be reached. Unfortunately there is a historic pattern of markets giving up ground the day after a Fed meeting regardless of whether they cut or not. I see no reason for it to happen tomorrow because there is so much pent up demand for equities. The S&P is trading at a PE of around 15 and that is the lowest it has been in years. With the global growth so strong analysts feel the S&P should be closer to a PE of 18-20 given the amount of S&P profits are generated overseas. The Dow may pull back simply because of profit taking from the +335 spike but I believe it would be a buying opportunity.

The Nasdaq duplicated the Dow's performance by eclipsing the 2644 resistance high from Sept 4th with a close at 2651. This leaves only the prior multiyear high at 2725 as resistance heading into the 4th quarter. Adobe reported strong earnings on Monday night and spiked sharply into today's open but pulled back intraday. Adobe's weakness did not rub off on the rest of the tech sector with a +70 point gain on the Nasdaq.

The S&P-500 blew past that troublesome resistance at 1490 to close at 1520. This is a major breakout and baring any problems with the rest of the financial earnings we should easily test 1535 later this week. The financials should be the power factor and take over from the energy stocks if their lead falters with the change in futures contracts on oil. Eventually this hysteria in oil will crack and it could get ugly very quickly for the sector.

S&P-500 Chart - Daily

Russell Chart - Daily

The biggest winner for the day was the Russell-2000 with nearly a +4% gain. This compares with the rest of the indexes around +2.5%. Either fund managers pulled the trigger on small caps or there was monster short interest in the Russell indexes ahead of a normally bearish period. I believe it was both. Small caps are normally weak in late September, early October and I think the bears had backed up the truck with every failure to break resistance at 800. When a few fund managers did view the Fed move as an all clear signal the bears were squeezed unmercifully. When I reverted to a bullish bias over 775 in the weekend newsletter I was seeing signs of buying starting to appear. I never envisioned a bounce of this magnitude in one day but I am definitely not complaining. Market internals were extremely lopsided with 6.4 billion shares of up volume compared to only 400 million shares of down volume. New 52-week highs at +293 were the highest since August 8th and the day before the August meltdown. A return to those levels should mean the bulls are back in town.

For the rest of the week we should see strength in financials leading to strength in the broader market. I am not even sure a bad report from MS, BSC or GS could sour the bullish sentiment. Don't be surprised if we see some profit taking and I believe it would be a buying opportunity. It appears the normal end of September swoon may have been eliminated this year unless some external event appears to roil the markets. The bull flag is flying and traders, even bearish ones, will be moving to a bullish bias thanks to the Fed's positively worded announcement and the potential for another hike in October. Very rarely does the Fed ever make a one and done type of move and even if it is two and through this year it still means rates are going lower. Buy the dips!

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