The Fed is unshaken by the rise in interest rates since QE2 began. Today they said inflation was too low and unemployment too high so the QE2 program would continue.

Market Statistics

The Fed left rates unchanged and repeated the "exceptionally low levels for the federal funds rate for an extended period" comment suggesting rates would remain unchanged for at least the next six months. They can't raise rates until they finish the QE2 program and begin removing liquidity from the market. Most analysts believe it will be 2012 before the Fed changes rates.

The Fed said it would continue buying up to $600 billion in longer-term treasuries by the second quarter of 2011. Not so heavily reported the Fed will also roll over maturing securities into new purchases of another $300 billion. In quantitative easing the Fed creates money and uses its new money to buy treasuries and remove those investment vehicles from the market and forcing investors to look for other places to put their money, preferably the stock market.

In theory this increases bidding for the available treasuries and drives up prices producing a lower implied interest rate. Unfortunately for the Fed the economy began improving about the time the QE2 program began and the European debt crisis flared up again. The European crisis pushed the dollar higher and the improving economy is convincing investors to pull out of bonds and chase stocks. That pushes interest rates higher. Both factors are opposed to the Fed's goals.

Since the interest rate has been rising instead of following there was some thought the Fed might warn of a potential increase in the QE2 purchases in order to force its will on the bond market and force rates lower. This did not happen but it does not mean the Fed can't change the program in the future. They left themselves and out with the sentence: "The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability." Also, "The Fed will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary." Those statements mean they can change policy at will if they deem necessary.

The Fed repeated the list of problems in the economy but noted again that a gradual uptick in activity had begun. However, "progress toward its objectives has been disappointingly slow." The Fed's objectives are low unemployment and price stability, which is normally expected to be a +2% inflation rate.

The Fed noted that consumer spending is "increasing at a moderate pace" compared with "increasing gradually" in the prior statement. However, they also noted the overall pace of business growth has slowed.

The tax compromise, which includes a cut in the social security tax and extension in unemployment benefits for millions of workers, should mean the Fed would not have to implement more aggressive policy actions to stimulate growth. Most analysts have raised their GDP estimates for 2011 by 1.0% to as much as 1.5% with the higher GDP predictions now in the +4.2% to +4.5% range. That would be nearly double the 2009 levels.

It would also put the Fed in a bind with nearly $3 trillion in treasuries on their books and rising interest rates pushing down their value as each day passes. A suddenly accelerating economy would also mean a greater fear of inflation and a need for the Fed to reverse its position very quickly. This is going to be a major challenge for the Fed when it occurs and they could actually end up killing the new recovery by too aggressive a revision in policy change.

The bottom line to the current Fed environment is a very accommodative interest rate policy at a time when the economy is poised to accelerate in 2011. As Ken Heebner said after the FOMC announcement, "we are expecting the economy to grow significantly over the next several years and this is a very attractive time to buy stocks. Conditions could not be better!"

The Senate test vote on the tax compromise was 83-15 in favor and when the real vote occurs it is expected to pass and move on to the house. This will be beneficial to the economy and with the Fed greasing the wheels we could actually see 4.5% growth by the end of 2011.

Elsewhere on the economic front the Producer Price Index (PPI) showed prices for finished goods rose +0.8% in November. The core rate without food and energy components rose +0.3%. The core rate was up +1.9% over the same period in 2009 but 1.7% of that was due to a rise in the sticker price of new cars. Wednesday's Consumer Price Index (CPI) will be the more important report with the level of inflation at the consumer level. I expect it to be tame or the Fed would have been more aggressive in their statement.

Retail Sales rose +0.8% in November compared to an upwardly revised +1.7% gain in October. Excluding autos sales rose +1.2%. I was surprised to see electronics and appliance stores post a decline in sales in November. You may remember the Black Friday sales actually started the day after Halloween and ran all month. I was expecting a good November for the electronics stores.

Of course everything is relative since November sales were still up +7.7% above November 2009. This was the third consecutive month of growth near 8% year-over-year. Sales are up at an annualized rate of +13.7% over the last four months.

There is a lot of pent up demand and most analysts have been projecting that demand increase in this holiday shopping cycle. I personally tried to visit a local mall twice in the last week and literally could not even get in the parking lot. Cars were lined up around the block just waiting to pull into the parking lot. Fortunately I was in no rush to spend money and went elsewhere. The real point is that December sales could be very strong.

Noteworthy reports left for this week include the CPI and Industrial Production on Wednesday and Philly Fed Survey on Thursday.

Economic Calendar

Another sign of a weak consumer was the implosion in Best Buy (BBY) today after they slashed their guidance and posted worse than expected earnings. Best Buy reported earnings of 54-cents for Q3 compared to analyst estimates for 60-cents. The company lowered its guidance for the full year to $3.20 to $3.40 per share compared to prior guidance of $3.55 to $3.70.

Evidently Best Buy did not discount prices enough to offset stronger competition from Wal-Mart, Target, Costco, Sears and Amazon. Those companies have said business was good and momentum was growing in electronics. Wal-Mart reported a "solid increase" in sales of LCD, plasma TVs and laptops.

The various smartphone apps that scan barcodes and tell you who has the same item for a cheaper price are getting a lot of play and creating some point of sale traffic. If you are standing in front of a $700 TV at Best Buy and your smartphone says Wal-Mart has the same model for $599 you are probably going to go immediately to Wal-Mart. Same for Amazon. If Amazon is showing it for $100 cheaper and it takes 2 clicks on your phone and no waiting in line then Amazon wins even with shipping.

Best Buy also said consumers were buying the cheaper priced models of flat panel TVs with screens 36 inches or smaller for $229 to $299 and that hurt both sales revenue and margins. Tablet computers are also credited with impacting sales of PCs and laptops.

Best Buy shares were hammered for a -15% loss.

Best Buy Chart

FedEx said Monday was probably the busiest shipping day of the holiday season with nearly 16 million packages moving through its system. That is a 13% increase over the 14.2 million packages handled on the same day in 2009 and it is double a normal days activity. About half of that increase comes from a deal with the Postal Service. FedEx ships lighter packages for the Post Office and delivers them to a local post office in the delivery area where the USPS takes over again for their final delivery to the address on the label.

Online merchants across the country are promoting this coming Friday as "free shipping" day and FedEx expects another spike in volume. Without the shipping promotions the online retailers would see their business drop off significantly in the week before the holidays. Their shopping season is almost over. Online spending is expected to increase up to 4% this year.

UPS expects its busiest day to be Dec-22nd when it expects to move about 24 million packages. That is 60% more than a normal day. UPS hired 50,000 part time workers to handle the load. For the entire season FedEx expects to ship 223.3 million packages and UPS more than 430 million. FedEx said the majority of its holiday shipments come from Amazon and other online retailers and mostly consist of books, cameras and electronics.

FedEx reports earnings on Thursday before the open. Estimates are for $1.31 per share.

FedEx Chart

In the recovery story of the century AIG gained another $3 today after the Chairman Steve Miller said he was encouraged about the company's prospects and they were more interested in BUYING insurance companies today than selling them. AIG has sold off dozens of assets to raise cash to repay the $49 billion bailout by the government. Their plan to pay off the loans and return the stock to private hands appears to be on track. The government owns 90% of the outstanding shares in AIG and they have to be very happy about the gains over the last couple of weeks.

AIG Chart

Bank of America raised their estimates for the S&P for 2011. They now believe global GDP growth will slow to 4.2% in 2010 from 4.9% in 2009 with emerging markets accounting for 80% of that growth. The bank still has one of the lowest estimates of U.S. GDP at +2.8%. However, the bank believes strong corporate profits in the U.S. will power the S&P-500 over 1,400 by year end. The 1400-1450 range seems to be garnering most of the estimate upgrades from the major analysts but there have been estimates as high as 1500.

David Bianco, chief U.S. equity strategist for BAC said 2010 was a good year for the markets but 2011 will me even better. Stocks are going to be an asset class that comes back into favor. Bianco said S&P 1500 is where he would expect the market to be by year end but the 1400 forecast is the banks cautious way of hedging their bet. He said oil should hit $100, gold $1500 but agricultural prices will decline as new crops replace those burned in the Russian fires or washed away in the floods.

In the energy markets there could be some volatility in crude prices this week. MasterCard's Spending Pulse report showed there was a 3% drop in gasoline demand last week and that was a heavy shopping week when consumers should have been bouncing from mall to mall. Gasoline over $3 per gallon in 21 states is weighing on consumers and they are electing not to drive any more than necessary. John, a reader in Maui told me he paid $4.10 today and reflexively stopped short of filling tank. (John, I think readers in the Midwest and Northeast suffering in the cold would gladly fill your tank if you would trade places with them this week.)

Oil prices over $85 per gallon are an economic drag because that is the level where those fill-ups start being painful to the discretionary budget. With so many people out of work and depending on unemployment for gas and food it is an even bigger problem.

With the current month crude contract expiring at the close next Monday I am expecting to see some profit taking from the nearly $10 spike we saw since Thanksgiving. We shorted the e-mini crude futures in OilSlick this afternoon.

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The markets appeared to express indifference to the FOMC announcement but bled a few points into the close when a sell program hit about 3:PM. I would not be surprised to see some real profit taking occur now that the FOMC is behind us. There was no change in policy and almost no change in the statement so a sell the news session would not surprise me.

The S&P touched a high of 1246 both yesterday and today and both times there was an almost immediate decline. Today's intraday low was a lower low at 1238 but the range was still minor. An eight-point range on the S&P with a positive close in the middle is nothing to worry about but I think the Best Buy cloud could be with us for a couple days. The FedEx earnings on Thursday morning could be a bright spot.

Support on the S&P is well back at 1225-1228 so there is some risk if real profit taking appears. Fund managers should use any dips to window dress into year-end so I don't expect any material decline.

S&P-500 Chart

The Dow finally moved to a new high at 11,514 after lagging the other indexes for the last couple of weeks. The move came on upgrades to Verizon, Kraft and Caterpillar. The Dow has decent support at 11,335 with today's close nearly 150 points higher. That gives the Dow plenty of room to wander without any material danger of breaking support.

Dow Chart

On the ninth day the Nasdaq rested. Yes, after a streak of eight consecutive gains the Nasdaq rested on Monday but the decline was minimal. After being up about 15 points intraday today the index came back to initial support at 2625 at the close. This was the result of a 3:PM sell program that hit all indexes. Several of the Nasdaq big caps were in negative territory like NFLX, FFIV and AAPL. After the strong December to date a little weakness was to be expected. I still believe funds will use this opportunity to window dress into year-end so today's action was not troubling.

Nasdaq Chart

The Russell completed its second day in negative territory but only fractionally. The Russell can decline to 765 without causing any alarm and I believe that level would be bought. After the performance so far in December it would be somewhat unbelievable to expect the run to continue without a rest.

Russell Chart

After the bell today TrimTabs.com reported U.S. stock mutual funds have taken in a net $2.7 billion so far in December. If the trend continues through year-end it will be the first month since April that stock funds have seen net inflows. Year to date stock funds have seen outflows of $69.8 billion in redemptions. Bond mutual funds have seen outflows in December of $2.3 billion. The tide is turning. Once the tax deal is in place and investors can look two more years into the future before worrying about an increase in capital gains taxes I believe the bond funds will hemorrhage money and stocks will benefit.

I don't have any particular market bias for the rest of the week but I do expect to see some higher highs before year-end. We could easily see some sell the news profit taking this week now that the FOMC is behind us. I would continue to buy the dips until proven wrong.

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