The Fed gave no hints of further quantitative easing and kept the warning of "significant downside risks to the economic outlook." Traders were not happy.

Market Statistics

Even though almost nobody expected any change in the Fed policy there always seems to be a disappointment factor when nothing happens. It is that ever present hopium causing traders to wish for something that is not there.

Rarely does the Fed make any changes in December and today was no exception. They said the economy was expanding moderately but they pointed out the apparent slowing of global growth. They appeared torn between the moderate improvement in the U.S. and the wave of darkness emanating from Europe and China. It would be really easy to read too much into this Fed statement because it only varied by a couple of adjectives from the prior meeting. They did say U.S. business investment was increasing "less rapidly" which would mean slowing growth in layman's terms.

The Fed said they would continue buying longer term treasuries and selling short term as in their prior statements. They also confirmed again they would keep rates low through mid 2013. Pimco's Bill Gross was doing some play by play commentary after the announcement and he said they will probably end up keeping rates low all the way out to as far as 2016. He said as long as the world is deleveraging the Fed and the ECB would have to keep rates extremely low or risk a disaster. With every bank in Europe selling everything from lucrative credit card businesses to gold reserves in order to raise capital for the real stress test in their future, any attempt to raise rates would cause an even worse global slowdown.

The Fed repeated their claim that inflation is slowing but did not bring back their warning about deflation. They did repeat the "low rates of resource utilization" likely to keep inflation at or below Fed targets. By keeping the Fed funds rate at "exceptionally low levels" for years to come they hope to avoid the return of the deflation monster.

There was one dissenter to the statement. Chicago Fed President Charles Evans supported additional policy easing at this time. He also supported additional easing at the last meeting.

Personally I think the stage is set for QE3 at the January meeting. Economic activity in Europe is going to continue to decline as austerity increases and budgets are slashed. Unemployment in Europe will rise as will unrest. It will not be a positive business environment. The Fed will need to implement additional monetary policy accommodation to keep Europe's malaise from spreading to the U.S. and killing our faltering recovery.

One point not mentioned in the Fed statement was the impact of its dollar swap program it announced a couple weeks ago. Because of the run on European banks five central banks announced a temporary plan to increase liquidity. Customers are taking money out in dollars instead of euros for fear of an euro collapse. The Fed will swap them dollars for euros to prevent those European banks from collapsing. We found out on Monday the ECB has already borrowed $50 billion from the Fed using those swaps. This is a form of QE lite and that will increase the Fed's balance sheet by the amount of swaps it allows.

In theory when the foreign bank enters into a swap agreement with the Fed it purchases a fixed amount of dollars from the Fed in exchange for its own currency at the prevailing exchange rate. The foreign bank's currency is held in a special account. The foreign bank has to buy back its currency at the same exchange rate plus pay interest on the dollars while the swap is active. Typically the swaps have maturities from as short as overnight to as long as three months. The foreign central bank loans the dollars to its own banks but the central bank is still responsible for repaying the Fed. If the corresponding bank failed the central bank would still have the repayment obligation to the Fed.

On the economic front Retail Sales for November rose +0.2% but that was less than the +0.5% in October and the +0.6% estimate. That is the slowest headline number since June. Electronics stores saw sales rise +2.1% but building materials, gasoline stations, food and beverages and restaurants all saw sales decline. Clothing stores rose +0.5%. Year over year growth slowed to +6.7% and the weakest growth since August 2010.

You have to wonder how bad it would have been without the extended sales for the entire week of Black Friday instead of just the weekend. Apparently consumers are not spending as much as previously thought.

The lower than expected retail sales added to the clouds over the market at the open.

The economic calendar for the rest of the week is highlighted by the Philly Fed Manufacturing Survey on Thursday. If we are going to see the economy start to slow again that would be the first major report to indicate that slowdown.

Economic Calendar

Also weighing on the market this morning was an earnings miss by Best Buy (BBY). The company said net income fell -29% due to price cuts in an effort to increase traffic for holiday sales. Tablets and TVs were the biggest discount categories. CEO Brian Dunn said customers are firmly focused on "value" this holiday season. Net income fell to 47-cents compared to analyst estimates of 52-cents.

Revenue rose only +2% to $12.1 billion and just shy of estimates at $12.13 billion. Same store sales rose only +1% but that was boosted by a +20% increase in online revenue. Best Buy has been running specials including free shipping to increase their online sales. Their profit margins continue to decline even though the company says it wants to be the discount leader. I guess you can sell anything if you sell it cheap enough but I thought the object of the game was to make a profit. Best Buy shares fell -15% on the news.

Best Buy Chart

Green Mountain Coffee Roasters (GMCR) fell more than 11% after saying K-Cup sales declined for the four weeks ended Nov 27th. The share of coffee sales by Green mountain declined to 8.4% of the market according to SymphonyIRI Group. That represented a decline of -0.4%. It would appear to be serious overkill on the stock drop for a fractional decline in market share. However, the key point here is that GMCR market share rose +3.4% for the same period in 2010.

Fund manager David Einhorn has also been highly vocal about his short in GMCR saying sales have peaked. GMCR is on the verge of losing its patents on the K-Cups and rivals are perking up all over with cups compatible with the Keurig coffee machines. An analyst at Dougherty & Co. downgraded GMCR citing data from researcher NPD Group that showed a widening spread between growth of GMCR brewer shipments and U.S. consumer purchases of coffee machines. Dougherty cut GMCR to neutral from buy.

Green Mountain Chart

Amazon (AMZN) declined -$9 despite a Goldman analyst predicting the company would sell six million Kindle Fire tablets this year and 15.5 million or more in 2012. The depressed stock price came from another analyst saying the Fire was a disaster and would never compete with the real tablets like the iPad. He felt Amazon was going to corner the market in ereader tablets but at $199 would have nothing to show for it. That is what makes a market. Electronic books are far more profitable and less effort than stocking and selling paper books. I download 5-7 books a month to my Kindle and I would never buy that many paper books again.

Amazon Chart

Gold declined -$50 intraday before closing at $1637. Gold fell -$30 after the Fed statement failed to mention any further quantitative easing.

The key mover prior to that was the sharp gap higher on the dollar to an 11-month high. The euro declined sharply to an 11-month low.

Historically an excellent buy signal on gold has been the 200-day average. Longer term the 30-week average on the weekly chart has been strong support. Unfortunately that weekly support broke this week. Gold bugs are either starting to get really nervous or they are getting really excited about the current buying opportunity.

The gold market has been under pressure from banks in Europe selling reserves in an effort to raise capital. The MF Global implosion took thousands of traders out of the market and many won't return. Funds in the U.S. are reportedly selling gold to lock in gains before year end with plans to jump back in next year. There is no scenario where gold does not set new highs in the next couple years. This is a liquidity event prompted by Europe and dollar volatility.

Bank of America Merrill Lynch issued a note recommending traders take profits in gold shorts and move to the sidelines.

Gold Chart - Daily

Gold Chart - Weekly

Euro Chart - 30 Min

Dollar Chart - 30 Min

Dollar Index Chart - Daily

Crude prices rocketed higher despite the sharp spike in the dollar after rumors broke that Iran was going to close the Strait of Hormuz just to prove it could. A legislator from Iran, Parviz Sarvari, told the news agency ISNA, "Soon we will hold a military maneuver on how to close the Strait of Hormuz. If the world wants to make the region insecure, we will make the world insecure."

Iran's energy minister told Al Jazeera TV last month that Tehran could use oil as a political tool in the event of any future conflict over its nuclear program. This is an often used threat. About 33% of all sea-borne crude supplies are shipped through the Strait. U.S. warships regularly patrol the Strait to ensure its safe passage. The channel is only four miles wide could easily be closed at least temporarily by almost any size military effort. However, closing the Strait would immediately incur retaliation by the U.S. military in support of our allies Saudi Arabia, the UAE, Kuwait, Qatar and Iraq.

Crude prices rallied more than $2 intraday to close at just over $100.

Crude Oil Chart

The markets swooned at the close on rumors S&P was going to announce a downgrade of Europe after the close. S&P listed 463 entities as most at risk of downgrades as of Dec-6th. That is up from 457 on Nov 1st. Today S&P said it removed 74 entities from that list and added 80 as a result of the EU decision on Friday. Jean-Michael Six, S&P's chief economist, said on Monday time was running out for the euro zone to solve its problems. "There is probably yet another shock required before everybody in the euro zone is reading from the same page, for instance a major German bank experiencing some real difficulties in the market and that is a genuine possibility in the near term."

The downgrade rumor did not come true tonight as of this writing but it could happen at any time. The new plan to create a new plan did not encourage anyone and there are already cracks in that agreement.

The market is interpreting these problems as a signal of severe market stress ahead. Like Mr. Six above, the market may need to undergo a traumatic event before investors are willing to move back into risk assets.

Most analysts believe the current EU plans for a fiscal pact will cure the next crisis later in the decade but it won't do anything about the current crisis. There is too much debt and nothing material is being done to reduce that debt. Merkel was quoted today as having said the ESM fund will be capped at 500 billion euros because that is all we need. Most analysts believe it will take between 2-3 trillion euros to solve the problem. Obviously we have a failure to communicate between the market and Merkel and without Merkel being fully on board with "whatever it takes" Europe will be forced to apply band-aid after band-aid while the infection spreads.

The S&P closed at a new two week low at 1225 and what used to be decent support. Futures are neutral after the close but that new low close suggests we will retest 1200 or even 1160 before the end of the year. Santa phoned in and said Europe had been naughty and he was cancelling his visit to Europe, China and Wall Street as a punishment.

I was negative on the market last Thursday and the short squeeze on the EU agreement surprised everyone. It rekindled a bit of my faith in the potential for an end of year rally but that faith has since evaporated. I don't see a catalyst to push us higher but there are plenty of storm clouds to keep us depressed.

The S&P closed right on the 50-day average and any further decline will be another technical sell signal.

S&P Chart - Daily

The Dow closed below 12,000 once again and right on the 200-day average. The Dow is not specifically moving average resistive but they still represent levels traders should watch. Moving under the 200-day will be a negative sentiment indicator and a move under 11,950 would be a new two week low. I believe traders will load up on shorts again if that 11,950 level breaks.

Dow Chart

The Nasdaq broke below support for multiple reasons. Amazon losing -$9 was no help. Neither was Priceline at -$13. The big culprit was the Intel warning on Monday. The PC sector is sick with hard drive shortage flu and earnings for Q4 and Q1 could show some big declines. The drive shortage of up to 60 million drives will not be corrected until sometime late in Q2 according to Intel although some production will come back to the market in Q1.

A lack of PC sales will mean weak chip sales for nearly every PC related product including monitors, video cards, ram, etc. Weak electronics sales at Best Buy are another symptom of potential earnings problems in the months ahead. The outlook for the tech sector is weakening and that suggests the Nasdaq could retest the November lows.

Nasdaq Chart

Russell Chart

Fed meetings tend to produce volatile markets even when nothing changes in the Fed policy. Hope for a change is built into the market and then extracted again based on the announcement. Today's FOMC meeting was no different.

The continued storm clouds over Europe are spreading to U.S. markets again and the cash drain on European banks is troubling. The plan to make a new plan has been cussed by everyone as lacking in its ability to address the current debt problems.

The tech sector is damaged by the floods. The retail sector was not as strong as it appeared on Black Friday. The Fed said business investment was increasing "less rapidly" meaning U.S. growth was slowing. They used to say if the U.S. sneezed Europe caught a cold. It would appear that Europe has a serious case of the debt flu and it may not be reasonable to expect the U.S. to remain untouched.

China is being mentioned nearly every day now as the next economic problem and traders are starting to move their attention from Europe to China.

The markets appear to be pricing in these problems. That may or may not happen in December but it will happen. There is still a possibility for an end of year rebound but as each day passes that potential declines. Funds that bought the earlier dips are probably hysterical with the thought the market might not hold up until year end. They may attempt some year end window dressing but the volatility could prevent it.

I am not overly bearish today but I am growing more cautious. I would take advantage of the next short squeeze to be long with small positions but I would look to take profits early. January may not be kind to traders.

The Ultimate Investor Newsletter

We are adding a new publication to the End of Year special this year. Option Investor and Premier Investor have gravitated over the years to shorter term trades. I am launching a different type of newsletter for longer term investors that don't want to be managing trades every day. The types of positions in the Ultimate Investor could last from weeks to months depending on the position. These will be lower volatility "investments" rather than trades.

This newsletter will focus on "story stocks" and special situations that provide us with a low risk opportunity to profit. An example would be a long term call option on Hewlett Packard when they fired their CEO and hired Meg Whitman to turn the company around. That would be a 3-6 month position. Another example would have been taking a position in Yahoo when Carol Bartz was fired and the company put up for sale. We will also take positions in stocks ripe for a takeover as we have seen in the oil sector with Global Industries (GLBL) and Brigham Exploration (BEXP).

Click here for Full Description of Ultimate Investor

Ultimate Investor will use all investment strategies including stocks, options of all types, spreads, etc. The type of strategy used will fit the special situation we are targeting.

This will be an investment newsletter rather than a trading newsletter. If market volatility has gotten you down then maybe something with a longer focus is what you need.

Subscribers to the End of Year Special below will receive six months of the Ultimate Investor Newsletter as well.

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Every December we offer the best prices of the year on a renewal package of our top newsletters. If you have been a subscriber for several years you know this is the best price and the best deal of the year.

This year we are offering Option Investor, Premier Investor, Leap Trader, Option Writer and our new newsletter starting in January, Ultimate Investor.

Please follow the link below to see for yourself the EOY subscription special for 2011. You will not be disappointed!

Jim Brown

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