The best gift is one that keeps on giving. The Fed provided that gift with their rate cut at the last FOMC meeting. We had a sharp rally on the news that led to new highs in the markets over the last couple weeks. Today the minutes from that FOMC meeting were released at 2:PM and that same meeting that produced the rate cut sent the markets to new highs once again.
Dow Chart - Daily
Nasdaq Chart - Daily
The key to today's FOMC spike came from what analysts read into those minutes and how that analysis carried over to the coming FOMC meeting on Oct-31st. There was surprising unanimity among the members towards the 50-point cut. Analysts were expecting some dissention with arguing over 25 or 50 points and concerns over what that would do for inflation. The minutes clearly showed the Fed was more concerned over the impact of the credit crunch than inflation. While inflation was discussed the members felt confident the decline in inflation would continue even if they cut rates. What the Fed feared was a significant decline in growth and jobs from the impact of the credit crunch. They lowered the growth outlook for Q4 and all of 2008 with expectations that growth would not recover until 2009. Members also felt the coming wave of foreclosures would further cripple the housing market, consumer spending and consumer confidence.
Basically the Fed changed its view completely to concerns over growth and inflation concerns disappeared. Since the FOMC meeting we have seen a resumption of activity in the credit sector. New deals are being announced, write-downs even at $25 billion so far were less than expected and all the major players said Q4 should be almost a return to business as usual. So if the Fed was worried about growth and business conditions those concerns have largely been erased. The subprime mess although far from being over is now old news and steps are being taken to lessen its impact on consumers. Inflation is continuing to fall and even high energy prices have failed to prop it up.
The FOMC minutes today, when coupled with the positive business outlook from the major banks and brokerages, set the stage for a strong Q4 rally. The Fed is not likely to cut rates when they meet in October but they are clearly open to that action should conditions warrant. With inflation no longer a concern the Fed will again move to the sidelines and the markets will be free to run without any negative concerns surrounding the next couple of Fed meetings. If by chance the Fed does cut again it would be icing on the cake. The comments about economic growth below potential for "a while" and lower rates "unlikely to affect adversely the outlook on inflation" still leave room for another cut this year but analysts are not going to bet on it.
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We are seeing things in the market that could convince the Fed to cut rates again even though the disaster has been averted by the recovery of the credit markets. The warning by Ryder (R) on Monday stressed that weakness in the housing sector was spreading to the broader economy. Ryder said, "Economic conditions have softened considerably in more industries beyond those related to housing and construction" - "consequently freight and shipment levels have weakened to a greater extent than previously anticipated." "Softer demand, lower pricing and higher costs will pressure earnings."
Today Oxford Industries (OXM) reported profits that fell -56% and blamed the drop on consumer credit problems, the sinking real estate markets and very challenging conditions in the retail sector. These two warnings and dozens of others before them confirmed the theory of weakness moving out of the housing sector. This subprime contagion is the wildcard in the Fed's future rate decisions. The Fed Funds Futures fell again after the FOMC minutes as expectations declined to 35% for future rate cuts but a weak earnings cycle could change that view.
With the earnings warnings this week the expectations for earnings growth gave back last week's estimate bounce and now analysts are expecting nearly zero growth for Q3. Those estimates have fallen from roughly 8.2% at the beginning of the quarter to +2% a couple weeks ago followed by a bounce to 3.2% on the Citigroup comments. That 3.2% has now evaporated and gone back to zero profit growth. This compares to 8.5% growth in Q2 and 22% growth in Q3 2006. Earnings between now and the Fed meeting on Oct-31st could push them to cut again. However, you may remember that Citigroup warned last week that too much earnings pessimism has already been priced in and there was more chance of an upside surprise than a downside risk. It is always easier for companies to over warn and then do better than under warn and do worse. The sky is no longer falling and the storm clouds are turning into just a slow drizzle.
St Louis Fed President Poole, one of the FOMC's more hawkish members, said today that the housing market will not stabilize until next year. He said the falling home prices are keeping potential homebuyers from entering the market. He called the current home market as "uncharted territory" and the forecast for home prices as "highly uncertain." He called the financial sector "fragile" but recovering. Based on these comments from an inflation hawk it appears even he is still open to another cut. He also called the drop in the dollar as "inexplicable." After the bell SF Fed president Janet Yellen said she was keeping an open mind about future rate moves because it was too soon to know how market woes would affect the economy. "Any forecast and analysis of events should be made with a great deal of humility about its correctness." She also said she would not be surprise to see inflation in the core PCE deflator continue to move lower. This should convince us that when all the Fed officials are telling us they have no clue, we should not be that confident in our own opinions.
The next set of economic reports likely to move the market will be on Friday. The Producer Price Index (PPI), Retail Sales, Business Inventories and Consumer Sentiment could combine to alter the current view of the Fed's next action.
After the close today Alcoa kicked off the official Q3 earnings cycle as the first Dow component to report. Alcoa reported earnings of 63 cents and missed analyst's estimates for 65 cents. Revenue declined slightly due to some restructuring. With the metals markets in full consumption mode I would have expected Alcoa to do better than miss by 2 cents. Higher costs are being felt along the food chain and even the darling in the aluminum sector is seeing profits squeezed. Alcoa is still thought to be a takeover target.
On Wednesday we will have earnings from COST, HELE, INFY, LRCX, MON and RT. LRCX would be my canary in the coalmine with the chip sector already weak. The SOX was the only index in the red today with a -5 point loss. A bad report from LRCX could further slow any Nasdaq advance. Costco should be a barometer for the consumer sector and a sharp decline in sales there would be evidence of further consumer pressure. On Thursday FAST, IDT, MTB, PEP, SWY, WGO and SLM will report. SLM will be the point of interest for the day with its current fight with J.C. Flowers about the aborted buyout. All of these reports are just foreplay ahead of the main event to come over the following two weeks. All the tech giants with the exception of Microsoft will report next week. With the Nasdaq the strongest of the major indexes these tech earnings will be the key to keeping the rally going.
Today was the 5th anniversary of the current bull market and by any measure it is getting old but you could not tell it from the levels reached today. All the major indexes with the exception of the Russell broke out to new highs or new 6-year highs in the case of the Nasdaq. It would not appear there is any fear of earnings when the indexes are breaking out to new highs a week before the earnings cycle begins. There is definitely no fear of the Fed and there appears to be no lingering fear of the economy, subprime loans, foreclosures, slowing retail sales and a drop in shipping traffic. The only fear remaining appears to be getting left behind in the Q4 rally.
The Dow ran for +120 points to a new high close at 14164 and only -2 points off the high of the day. No shyness there ahead of the Alcoa earnings. Despite missing estimates Alcoa gained slightly in after hours after closing at a new 2-month high before the earnings. Nobody seems concerned about the estimate miss. Bad earnings news appears to be no longer a concern with all the pessimism currently priced into expectations. The Dow has support at 13950 and resistance at about 14250. Those numbers are lost in the analyst chatter with 15,000, 15,500 and even 16,000 now being mentioned as highs before year-end. All the stars appear to be aligned for this rally and that should be a worry in itself. When conditions are too perfect they normally are and we just havent seen the speeding truck heading our way.
The Nasdaq blasted off to close over 2800 for the first time since Jan-24th 2001. The Nasdaq has not had two consecutive losing days since Sept-10th. It has rebounded more than +400 points since the August-16th low and the angle of ascent is increasing. That could be the reason the Nasdaq lagged the other indexes on a percentage basis for the day. With all the major tech earnings next week there could be some profit taking creeping into the picture before the event. I do believe any dip will continue to be bought but next week I would be more cautious until we hear from Intel, IBM, GOOG, AAPL, etc. While everyone expects computer sales to be strong based on recent reports we don't know for sure if that is going to translate into profits.
While the Dow and Nasdaq have been making new highs the S&P has been lagging. Resistance above 1554 has been tough but it appears to have finally broken with today's gains. This should produce further short covering by those bears still hoping for an October decline. Short interest is dropping rapidly and this will eventually slow any further advance. Without shorts acting as our stepping-stones to new levels the road higher could be slick and lacking traction for the bulls. The S&P has good support at 1540 and again at 1520. Next resistance is around 1585 with many year-end targets at 1585-1600. On that basis it would suggest that the upside on the S&P could be limited.
S&P-500 Chart - Daily
Russell-2000 Chart - Daily
The Russell 2000 is the only major index that has not broken out to new highs.
The Russell closed at 845 and still 10 points below its July highs. As my
sentiment indicator I am still bullish on the Russell for its +65 point gain in
just the last 3-weeks. It started later than the other indexes and waited for
the rate cut before blasting off. I definitely expect some resistance slowing at
855 but baring any serious earnings disappointment I think we will get through
it. The bulls appear
to be in control and there is nothing on the horizon the
rest of the week that might derail them. Next week should also be bullish but
that really depends on the earnings. Keep your fingers crossed there is no
speeding truck heading in our direction.