The FOMC minutes showed most Fed members were ready to pack their bags and head out on a new quantitative easing voyage.

Market Statistics

The minutes from the September FOMC meeting showed that most members were concerned about the slow pace of job creation and the weakening economic recovery. Inflation remains well under their targets but they expressed no concerns about a deflationary period. The minutes clearly showed a Fed that was ready to launch a new quantitative easing program sooner rather than later. The question is no longer if they will do it but how much will they spend?

Some of the positive comments mentioned included a continuing global recovery in progress. Emerging markets were strong. Yields (interest rates) remained low and bank lending was beginning to loosen. Consumer spending was stronger.

On the negative side inflation was too low and was expected to remain very low through 2012. The real estate market remained sluggish and sales of commercial mortgage backed securities was very low. Business lending continued to decline.

The FOMC cut its outlook for growth for the second half of 2010 and all of 2011 with a strengthening in 2012. The declining outlook for growth and inflation prompted many members to urge additional monetary policy accommodation. Others were in favor of new policy only if conditions worsened. They discussed different types of policy accommodation but settled mostly on buying additional longer-term treasuries. There was no direct mention of purchasing equities as Japan recently announced.

The differing views among the members prompted the FOMC to hold off on further policy changes until the next meeting (Nov-3rd) in order to see more economic data before taking the plunge.

Overall the language in the minutes coupled with the continued loss of jobs indicate the FOMC will adopt further "aggressive" steps at the November meeting unless economics suddenly improved significantly. The statement clearly showed that the committee considered a series of strong policy moves at the September meeting but wanted to err on the side of caution and wait for more data.

I am sure the election rather than data were the number one reason they did not act in September. Had they launched into another aggressive QE2 they would have been handing the politicians loaded guns to use in their campaigns. Fed policy is normally seen as a negative to any existing administration and ammunition for the party out of power.

A QE program creates money electronically and the Fed uses its new money to buy treasuries, equities, mortgage backed securities, etc. This floods the markets with cash and depreciates the value of the dollar. With the Fed using their new money to bid on assets it creates competition for those assets and increases the price. In the case of bonds or treasuries that drives down the interest rates and in theory it lowers interest rates all across the markets. Private money that would have been invested in treasuries but was outbid by the Fed is forced to go elsewhere and that pushes rates on other securities lower. Some of that money eventually finds its way into the equity market and pushes equities higher.

The analyst community is pretty much in agreement that the Fed will purchase at least another trillion dollars in treasuries. However, some analysts have speculated they could buy up to five trillion in total over the next year. With the Fed going for QE2, 3 or even 4, there is no chance of a rate hike in the near future. Most now expect the first Fed rate hike well into 2012. The "extended period" language or similar will be with us a long time.

There was an in-depth discussion of whether the employment problem was structural or cyclical. Structural unemployment would favor tighter monetary policy. That would force a shift in employment away from sectors like homebuilding and into sectors that would drive the recovery. Cyclical unemployment means that demand is simply too low and keeping interest rates low would eventually stimulate demand so that hiring can begin again. Most analysts believe we are experiencing cyclical unemployment and the Fed is on the right track in acting aggressively.

The biggest problem with a large QE program is the eventual removal. The Fed is getting in way over their head here and removing $2-$3 trillion dollars of cash from the market before they can begin to raise interest rates is going to be a major challenge. In theory the economic recovery will be well underway with solid growth in the 4% GDP range but that will still be a major challenge. Extracting a couple trillion from a $14 trillion economy is no small chunk of change. We will be further down the deficit road with a gridlocked administration. The foreign appetite for American debt will be even less at the time the Fed will be selling their treasuries back into the market. This is going to be a horrendous mess in 2012 and beyond but for the time being the equity markets should continue generally higher through year-end.

You will be hearing the phrase "don't fight the Fed" a lot in the coming months. When the Fed is printing money at the rate expected the market bears are going to have very few opportunities for wholesale shorting of stocks. Individual issues yes but broad market declines should be very brief once the next program starts. It will probably be announced on November 3rd but will not likely commence until January.

That means there is nothing from the Fed to actually push stocks higher for the rest of October other than expectations of the coming program and most of those expectations are already baked into the market cake.

The FOMC minutes were the biggest economic event this week. The PPI and CPI are likely to be ignored because there is no inflation.

Economic Calendar

In stock news it was earnings taking center stage. CSX Corp (CSX) reported earnings that rose +43% on cost cutting and higher shipments. CSX said it was using fewer cars and locomotives to control costs as the economy slowly recovers. CSX also said it was bringing back laid off employees as business improves.

CSX reported earnings of $1.08 per share beating expectations of $1.04 per share. Revenue rose +16% to $2.67 billion. CSX shares gained +$1.25 in after hours trading.

Obviously CSX was not the earnings report everyone was anticipating. The real market mover was Intel, which reported earnings after the close. Intel reported earnings that rose +59% and sales that increased 18%. Earnings per share was 52-cents and that beet analyst expectations of 50-cents. Those expectations had been lowered after Intel warned in August that sales of computers had slowed.

Intel said today that results would have been better if the economic decline in August had not trashed the back to school season. After two months of warnings from chip companies the earnings from Intel were a breath of fresh air. CEO Paul Otellini said Intel continues to see "healthy worldwide demand for computing products of all types." Intel expects sales to continue to increase in Q4 but at a slower pace than in the first half of the year.

Intel's gross margin guidance was 67% and at the high end of the range. Intel said there was an absence in seasonal trends but that corporate buying was driven by solid demand. Sales of products for servers and workstations rose +30% for the quarter.

Overall it was a decent report and Intel's shares rose in afterhours trading. The amount of the gain was insignificant at 20-cents but at least they did not collapse. This was a market hurdle that had to be crossed.

Intel Chart

Linear Technology (LLTC) reported earnings of 59-cents and missed the analyst estimates by a penny. The also said sales in the current quarter would be light to down -4%. Shares of LLTC fell -2% in after hours.

Chevron (CVX) warned that Q3 earnings would be less than Q2 because of a drop in U.S. production, higher costs and the impact of a weaker dollar. U.S. production in Q3 declined to 692,000 bpd compared to 708,000 bpd in Q2. Elsewhere production rose by 3,000 bpd to 2.041 million barrels per day. The total of 2.73 mbpd was short of Chevron's target of 2.78 mbpd. The company said the decline in the dollar would reduce earnings by about $400 million for the quarter. Chevron received an average of $76.50 per barrel in the quarter. Chevron declined about a dollar in after hours. This will probably drag on the other major oil companies on Wednesday because the dollar impacts everyone.

This earnings warning from Chevron is the first of what will be many due to the decline in the dollar. Over the quarter the dollar declined roughly 8.4%. For companies that do most of their business internationally (63% of the S&P) this is a major drag on profits. This is the negative side of quantitative easing.

Earnings are just getting started this week and the majors left to report include JPM on Wednesday, Google on Thursday and GE and Schwab on Friday. Next week is a veritable avalanche of reports that will cover every sector. By the end of next week we will know how the season will end and the excitement will begin to fade.

The drilling moratorium is dead. With elections only three weeks away the Obama administration finally bowed to pressure and lifted the drilling moratorium. Unfortunately it was an empty gesture. Interior Secretary Ken Salazar said they were lifting the moratorium today and they were open for business. Unfortunately because of the new rules required to get a permit it may be March or April before any deepwater drilling is restarted.

Some of the rules require beefed up blowout preventers and those are in short supply. Cameron International says they have a very large backlog of orders that will take several months to fill. Secondly and the biggest gotcha to being "open for business" is that companies must certify they have adequate "containment facilities" to prevent oil from a blowout from escaping into the Gulf.

The term "containment facilities" means they must have the equipment available to lower over a blown out well to capture the escaping oil. Nobody has this since everyone in the past has relied on the blowout preventer to cut off the flow of oil after a blowout. There is a consortium of major oil companies including XOM, CVX, COP, TOT and PBR that are building a generic containment system for the Gulf at a cost to the group of more than $1 billion. This containment system will not be ready until March or April so it will be tough for any single company to certify before then they have an adequate containment plan in place.

The new rules also require a "professional engineer" to independently inspect and certify each stage of the drilling process. Also, blowout preventers have to be independently certified as functional and capable of shearing the pipe in use in two places. There were 36 rigs sidelined by the moratorium and 18 of them are affected by the containment system clause. Those working in shallow water doing development rather than exploration could resume operations with fewer hurdles.

One of the rules requires the CEO of the company to certify that it complied with all regulations. That will make the CEO liable for all future accidents. Senator David Vitter (R-LA) claims the new rules are a de facto moratorium on drilling that could extend for months of even years. Senator Mary Landrieu (D-LA) applauded the decision but refused to release her hold on the nomination for Jacob Lew to head the OMB. Landrieu blocked the vote on the president's nomination of Lew until the moratorium was removed. She claims the new rules are too onerous. The White House called her actions "outrageous" and "unwarranted."

Transocean Chart

Todd Hornbeck, CEO of Hornbeck Offshore Services also said the new rules were still a moratorium against drilling even if the government claimed it was open for business. Until the government fully explains how new drilling permits will be issued "we are still in the dark." His company had sued to block the initial moratorium.

LA Governor Bobby Jindal welcomed the announcement but said he would watch closely to see if permits were actually issued. Industry groups also expressed skepticism over the continued "de factor moratorium." That term was used in at least a dozen press releases by different groups and individuals so the feeling of a continued suppression of drilling is very widespread. This boils down to a token response by the administration ahead of the elections in hopes of not losing any more votes. Since most workers and residents around the Gulf coast understand more than the common citizen about the process this is more flash than substance from Salazar.

Remember the administration created this moratorium so it appeared they were in control. When it was blown up into such a big controversy they could not figure out how to get out of it gracefully. Basically they talked themselves into a corner defending it and now they have to justify all those reasons they gave when it was initiated. The industry has drilled over 55,000 wells in the Gulf and the Horizon accident was the first disaster of its kind in the 50-year history of Gulf drilling. Mexico had a well blowout in 90 feet of water but the U.S. has a very strong track record and no reason for the shutdown of the industry for another 4-6 months other than politics.

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ISupply said Android smartphones stole significant market share from Apple in the last quarter. HTC Corp, which makes the Droid for Verizon, say sales increase +63%. Samsung sells the Galaxy line of Android devices increased sales by 56%. Nokia saw sales rise +12% and Research in Motion gained +7%. Shipments of iPhones declined by -4% in the quarter. Apple shares ignored the news and rallied to a new intraday high at $299.50.

The S&P rallied to close in positive territory at a new five month high of 1169. That was a gain of +4 points and relatively muted after the FOMC minutes came out as expected. That is the real key. The minutes had been expected to show the Fed going deeper into an aggressive monetary policy. The news was already baked into the cake. There was also a little worry that the various comments about "some members" disagreed with various portions of the discussion and that put a little fear into investors that maybe there were still some objections to overcome before QE2 was launched.

This poses a interesting problem for the markets on Wednesday. The Fed will probably ease again. Ok, nothing new there. Intel posted strong profits and beat the lowered estimates. They really did not have anything earth shaking to say on the positive side. Business is good but no seasonality. Translated that means consumers did not buy for back to school and they are not seeing any ramp up for the year-end holiday season. Is that good news?

On Wednesday we will have earnings from JP Morgan. That will give us insight into the banking sector and that sector has been lagging the rest of the market. Good news could help push the sector higher and offset some other losers. Bad news could seriously tank the sector and drag down the market. We almost never see a material rally without the participation of the financials so the JPM earnings are important.

Google could be a real disappointment on Thursday. Yes they have a car that drives itself and they have a wind farm and a solar farm, etc, but are they being distracted from their main business of search results? We learned this week that Internet advertising set a new record in September. Did Google profit from that record or were they off scheduling races to Mars and working on a replacement for tofu.

The S&P closed at 1169 and has strong resistance at 1175. I am worried that these pending earnings reports plus the old Fed news could give traders a reason to back off until next week. I would be reluctant to enter new long positions on Wednesday.

We did see a major dip bought at the open with the Dow down -97 but that was before the Fed minutes. That may have been more short covering than bullish buying. I recommend caution here.

S&P-500 Chart

The Dow eased back over 11,000 but only barely. After being down -97 at the open it was a decent recovery but +10 points after a confirmation of further easing ahead is a clear indication traders were not impressed by the news. Uptrend resistance from February is still holding and the Dow futures are nearly flat late today. However, the dollar is declining overnight and that should be positive for equities. It is a tough mix of factors for Wednesday be prepared for anything. Initial support is 10,970.

Dow Chart

The Nasdaq was the most bullish index with a solid break through the 2400 barrier. This sets up a test of resistance at 2425 on Wednesday. The big cap techs are still driving the market. Apple, Amazon, NetFlix and Google remain the favorites and the morning dip was bought with higher volume on the Nasdaq than the other indexes. Funds are evidently still looking to get long these big names before their fiscal year-end on Halloween. Support is now well below at 2380.

Nasdaq Chart

The Russell closed below yesterday's high with only a .37% gain for the day. This compares to .64% for the Nasdaq, .38% for the S&P and .09% for the Dow. Over the weekend I warned that when the Russell started turning in a lower percentage performance than the big cap indexes I would worry about the market. Today's gains were neutral and did not give us any real clue. The Dow was the laggard but I attribute it to pending earnings by Intel, JP Morgan and GE. The Dow ETFs were not being bought on volume.

Continue to watch the Russell for an early warning signal if the market begins to weaken.

Russell Chart

In summary volume was lackluster at 7.2 billion shares and it was a pivotal day in the market. You would have expected a little more participation. It was 2:1 in favor of advancing shares but that came primarily from the opening rebound. Volume on the dip was low but it picked up on the rebound.

There are critical earnings left with JPM, GOOG, GE and this is an expiration week. I would not be surprised to see some accelerated volatility. Watch the Russell as an early warning signal for market direction. We could still have an October surprise with 13 days left in the month.

This is going to be an event driven market until after the elections so keep your seatbelts fastened and your stop losses in place.

Jim Brown