The markets continued to move higher after the Fed elected not to rock the boat and left rates unchanged.
Market Stats Table
The big news today was of course the FOMC meeting and the Fed's decision to leave the language unchanged. The Fed announced it would leave rates "exceptionally low - for an extended period." That was the key sentence in the entire announcement although it did contain several positive data points. The Fed said the labor market is stabilizing compared to the prior statement of "deterioration in the labor market is abating." The Fed noted significantly improved household spending and stronger business investment in equipment and software.
However, the Fed also said constraints on the economy included high unemployment, weak wage growth, reduced home equity wealth and tight credit. The Fed again said "the pace of economic recovery is likely to be moderate for a time with gradual return to higher levels of resource utilization." In other words don't expect a booming recovery any time soon.
They also said inflation was not a problem using the same language as before. "With all the slack in the economy, inflation is likely to remain subdued for some time." The Fed reiterated they are ending their support of the mortgage market when their $1.25 trillion purchase of mortgages ends this month. That program provided support for low mortgage rates by purchasing an average of $75 billion in mortgages every month. Once that program ends it will be up to banks, insurance companies and investors to pick up the slack and mortgage rates are expected to rise. That will be especially true after the homebuyer tax credit ends this spring.
Eventually the Fed will have to do something with the nearly $2 trillion of assets it has acquired over the last couple years as it worked to support the financial markets. The Fed will have to sell these back into the market at some point. How that will happen is unknown as is the timeframe for the process. You can bet it won't be in 2010. To the extent some of the securities were short term they can just let them mature but the mortgage-backed securities will eventually need to be sold.
The decision was not unanimous with the Kansas City Fed President Walter Hoenig voting against the extended period clause. Hoenig believes the Fed rate should be closer to 1% to avoid a build up of inflation pressures. He argues that 1% is still exceptionally low for a Fed rate. Bernanke believes the economy will take some time for growth to become self-sustaining and not dependent on Federal stimulus. When the Fed does decide to raise rates they will probably do so aggressively to avoid a bubble like the one that developed after the 2002 recession.
Bernanke will testify on Wednesday and he is likely to reassert that extended period statement. However, quite a few analysts are now expecting it to change at the two day FOMC meeting in April. Just changing the statement does not mean the rates will change. It is simply a movement back to a neutral bias rather than an exceptionally low bias. It would still take several meetings to move to a tightening bias to give the markets time to prepare. Moody's does not expect the Fed to actually raise rates until early 2011.
The housing market and unemployment will be the criteria that pushes the Fed off its current bias. The housing market is expected to collapse again this summer. The homebuyer tax credit expires at the end of April. Homes must be under contract by April 30th to qualify. Once the tax credit ends most analysts expect home prices to drop another 6-8% by year-end. The Fed will want to see a housing market improvement without stimulus before changing rates. Secondly the 16% U6 unemployment is a continuing drag on the economy. Until the labor market is consistently adding jobs the Fed should remain on hold.
While on that topic the estimates for the payroll report on April 2nd are rising by the day. Numbers being tossed around are averaging 400,000 new jobs with as many as 600,000 in some estimates. As these numbers gain more credibility in the market we are setting up for a major surprise if they don't come to pass. The bullish estimates are simply exceeding reality and taking on a self-propagating life of their own. I am sure there will be job gains but the market is setting up for an ugly surprise.
Other economic reports included the New Residential Construction for February. Housing starts fell by -5.9% from the 18 month high in January. Analysts blamed the drop on the winter storms but I believe there were other factors. Builders are racing to complete homes before the tax credit expires. Since they have to be contracted by April 30th and close by June 30th the window for builders is closing fast. With a 4-6 month construction process for a custom home the optimum start date would have been January. Starting a new home in March does not give enough time for the closing and occupancy by June 30th. Starting in February would have been marginal. Builders don't want to end up with a bunch of new homes being rushed to completion in late June with no buyers. That means there must be completed models available no later than April for buyers to tour. I don't think the drop in starts was due entirely to weather and I expect another drop in March. With home prices expected to drop 6-8% by year-end builders are not going to want to carry a lot of inventory past April 30th.
The best thing the government could do to stimulate the economy would be to extend the homebuyer tax credit until September 1st. Most families can't/don't move during the school year. Homes are sold in the spring and families move over the summer break. Forcing them to buy earlier in the spring than normal prevents some from making the decision. Most families also have to sell their existing home and most home sales are in April-June. Extending the credit for two more months would extend the building/selling season into the normal range and allow more existing home sales to occur and maybe prevent some more homes from entering the foreclosure process.
The remaining reports of note this week are the Producer Price Index (PPI) on Wednesday and Consumer Price Index (CPI) and Philly Fed Survey on Thursday. By far the most important event will be the grilling of Bernanke when he testifies on Wednesday. Bernanke is the Fed for all practical purposes so what he says matters. The question of the "extended period" comment and how much longer it will remain in the statements is sure to be asked.
In stock news Intel (INTC) announced its newest server processor and said hundreds of thousands had been presold. The new chip has six processor cores and is the first chip using the new 32-nanometer process. The chip delivers 60% greater performance than the prior generation of processors. The processor also runs on significantly lower power of as little as 60 watts. The six-core processor is also multithreaded and appears to the operating system as 12 processing cores. This is a major announcement for Intel and they claim 12 new world speed records for things like virtualization performance.
Intel stock was also rising on expectations for a positive pre-earnings announcement. However, Intel has changed its requirement for a preannouncement and it may not happen. Broadpoint analyst Doug Freedman said Intel will not preannounce unless the senior management receives information suggesting earnings will be significantly outside its prior guidance. With the surge in PC sales there are many people who believe this will occur so shares are surging higher. Add in the short covering from the morning chip announcement and Intel closed at a new 15-month high.
Lehman submitted a plan to the bankruptcy court to exit bankruptcy by putting all its assets into a newly formed company called LAMCO. This company would serve as an asset manager for the remaining Lehman assets. LAMCO would capitalize on the existing infrastructure to handle the long-term assets and the illiquid assets. The company said it developed LAMCO to specialize "in the management of commercial real estate, residential mortgages, principal investments and private equity, corporate debt and derivatives assets." Lehman has spent $642 million in the bankruptcy process and claims this new company will save billions in future suits and management fees and will accelerate payments to creditors. Shareholders will get nothing.
Harley Davidson (HOG) spiked $2 on rumors of a takeover by KKR. The 7% gain was blamed more on short covering on the news rather than the potential for an actual buyout. Harley refused to comment on the market rumor. Harley has better than a 15% short interest. Option volume was 500% more than normal. KKR declined to comment but did not disclaim the rumor. Harley has been severely depressed since hitting a high over $75 in November 2006.
Chart of HOG
General Electric is up 10% this week on news they were going to resume growing their dividend in 2011 after cutting the dividend in Feb-2009 for the first time since the 1930s. The move preserved about $9 billion in cash to help it through the financial crisis. GE said the restructuring of GE Capital was progressing although loan losses would peak in 2010. A rebounding GE is a sign investors believe the overall economy is improving. Investors are not buying GE at $18 today because the dividend may go up a nickel in 2011. They realize that GE would not make this announcement if they did not feel better about the economy and about their business model.
Chart of GE
The neutral Fed statement, the Intel pre-announcement rumors, GE's dividend news and many more events just like that helped to power the S&P to a new high at 1159. That is the highest close since Oct-1st 2008. The Nasdaq rallied to 2378 and the highest close since August 28th, 2008. The markets are in full breakout mode with the exception of the Dow.
The Dow gained +44 points to 10685 and it is closing in on resistance at 10725 and the high close for January. The four-week drop into mid February has been erased and the Dow is very close to joining its brethren in making new highs. We are likely to see money flow into big caps as the quarter ends because the small caps and tech stocks are so strongly overbought. If you are a fund manager today looking to put some new money to work you are probably not going to buy the small caps at this level. You would probably find the lagging blue chips more attractive and safer from a liquidity perspective as the quarter ends.
This is also a triple witching options expiration week and volatility is likely to increase and that makes big caps a safer bet. As the Dow approaches the 10725 resistance high we are also facing a clear test of market sentiment. The other indexes may get their share of honorable mention in the press but the Dow is the sentiment indicator for John and Jane Doe. What they read about the Dow in the morning paper goes a long way towards their decision to move cash from savings back into the market. It is rather sad since the next four weeks are likely to produce a market top as we head into the "sell in May" period and the summer doldrums.
On the Dow we have seen decent support form at 10575 and any minor news over the rest of the month is probably not going to break below that support. If the Dow does manage to break over 10725 on decent volume we could get a solid run into month end on short covering and retail traders chasing the market. The next material resistance for the Dow is around 11250.
The S&P is our major indicator for today. The S&P finally pulled away from the price magnet at 1150 and moved into a clear breakout. This is even more important since this is a triple witching expiration. S&P 1150 was the max pain point strike and to move this strongly away from that strike is a strong indicator and suggests we will see further short covering into month end. The 1150 level may come back to haunt us but as support on profit taking rather than resistance. This breakout is very bullish. Overhead resistance should be around 1185.
The Nasdaq rallied on the strength of Intel although all the other tech majors were also up with the exception of RIMM. The Nasdaq rally was .6% and it was the laggard of the group after breaking out last week. The Nasdaq was overbought and needed a rest. Monday's dip was barely sufficient and it was erased with today's gains. The breakout to 2378 was only two points over last Friday's high but it still counts. If Intel pre-announces much of that anticipation is already priced into the market but the chip sector in general still has a ways to run before becoming overbought. The SOX has been lagging the broader tech market. Support should be 2350 on the Nasdaq with resistance just over 2400.
The Russell slowed its ascent over the last week as it became severely over extended. Tuesday's new closing high is not a really bullish event since it is just over the congestion from the last five days. Another move higher from here could produce more short covering from those who thought the run was done. The next material resistance is 725 and that gives the Russell plenty of room to run but I am not sure traders have the conviction to buy the Russell at this level. I would be cautious here in favor of the big caps into month end.
Russell 2000 Chart
In summary, this is a triple witching expiration week. For all practical purposes the S&P print at Thursday's close will be the key indicator of market sentiment. I believe fund managers are locked into a performance race into month/quarter end and that may cause them to be a little more bullish than is indicated by the market. The expiration volatility could cloud the issue.
Historically the day after a FOMC meeting is normally down as a sell the news event. Traders hoping for the best result were long into the meeting and they move on once the fireworks are over. Today's meeting had no fireworks so all eyes will turn to Bernanke and his testimony on Wednesday. I don't expect the PPI/CPI reports to be material market movers. I would focus on planning my trades with month end in view and the payroll report as the climactic news event on April 2nd. I would probably sell into any post jobs rally.