The market was pretty quiet as traders held their positions ahead of Yellen's press conference on Wednesday.

Market Statistics

The Dow and S&P edged slowly higher ahead of the FOMC announcement and Yellen press conference. However, the Nasdaq and the Russell 2000 surged ahead and provided a sentiment boost to the overall market. When the small caps and tech stocks are leading it suggests the big caps are poised to make new highs as long as Yellen does not disappoint.

That is a big IF because the spike in inflation as represented in the CPI this morning could cause some uneasiness around the FOMC conference table this week. How Yellen addresses that point in the meeting statement and the press conference could either power the market higher or send it off the cliff.

The Consumer Price Index (CPI) for May rose +0.4% overall and the core rate rose +0.3%. This was the seventh straight month of gains. While that may not sound like much the monthly gains from February to May were +0.1%, +0.2%, +0.3%, +0.4%. Are you seeing the trend there? The core rate progression since February was +0.1%, +0.2%, +0.2% and +0.3%. The Fed can't say this time that it is only the headline rate increasing while the core rate remains muted. Both are moving in the same direction and picking up speed.

The real kicker is the 12 month inflation rate. In February it was +1.1%, March +1.5%, April +2.0% and May +2.1%. The core rate rose from 1.6% to 1.9% over the same period.

Energy prices rose +0.9% in May. The food and beverages rose +0.5% and the food at home component rose +0.7% and the biggest gain in three years. The trailing 12 month rise was +2.5% for overall food prices.

The recent spike in oil and natural gas prices is going to cause havoc with overall prices in the coming months. There is almost no way we won't see a continued surge across the board and the Fed is not going to be happy. They continually claim that inflation is subdued and will remain low for a long time. Over the last four months that claim is starting to wear thin.

There is a growing number of analysts that believe the Fed will have to accelerate its timetable for rate increases and possibly even end QE earlier than expected. This makes the FOMC statement and press conference this week especially troublesome. They have to mention the rising inflation and how they view the coming months. This could be a touchy topic and the market should be concerned.

As you can see in the chart below inflation has been abnormally low since the recession and there were a couple spikes that eventually faded. I expect the FOMC to say this is another spike as a result of the snapback in demand from the harsh winter and factors like the rising energy prices that will eventually fade.

Also weighing on the FOMC meeting will be the drop in new residential construction for May. The headline number came in at 1,001,000 compared to April at 1,071,000. Estimates were for 1,036,000 new homes. That -6.5% drop from April in what should be the busiest part of the building season is definitely troubling. Single family starts declined from 664,000 to 625,000 and multi-family starts fell from 407,000 to 376,000.

The decline in activity was nationwide and not just one region. The Southern region did buck the trend with a +7.3% increase in starts. Permits fell -6.4% to 991,000 and now -1.9% below year ago levels.

Analysts tried to use the weather excuse again saying the surge in April was the snapback in starts and not really a new trend. They may be right since starts in January were 897,000, February 928,000 and March 950,000. The weather did depress the late winter months since December, not normally a big month, did register 1,034,000 starts. The three month lull was definitely weather related and that lends credence to the snapback theory in April.

Regardless of the weather the Fed will be discussing the weakness in housing along with their future plans for cutting stimulus.

The calendar for tomorrow is highlighted by the FOMC announcement and the Yellen press conference. The worry for me is how Yellen handles the rising inflation in the press conference and the potential for an accelerated end to QE. Potential changes to the current QE taper are extremely unlikely but always a possibility.

This could be a pivotal meeting for the Fed. The economics are slowly improving and earnings estimates for Q2 are nearing four times the +2.4% growth in Q1. There is some incentive for the Fed to stand pat and just let the QE expire at the current pace because ending it early could upset the markets before the economic rebound becomes self sustaining.

Thursday's Philly Fed Survey would normally be a highlight for the week as the first major manufacturing report for June but it will probably be lost in the whirlwind of headlines left over from the FOMC events and the Iraqi war.

Friday is a quadruple witching and that is normally bullish. However, the week in June after the quadruple witching has been down 21 of the last 24 years. There is probably some technical explanation for the decline but it may be as simple as the arrival of the summer vacations and investors are cashing out and heading for the beach.

Also on the calendar for Wednesday is the Amazon smartphone announcement. The phone is widely rumored to have 3D features thanks to six tracking cameras that feature facial recognition to tilt the images depending on how the phone is held in relation to your face. Amazon is expected to sell the phones for just over cost and that could upset the current balance in the smartphone market.

On the downside there is a rumor that they signed an exclusive agreement with AT&T for service. That would be a negative since the AT&T network is less dense with large blocks of the country having spotty service. Amazon has been having talks with the major carriers in Europe but no word on which one has the best chance for getting the contract.

Samsung had a 31% market share of the 288 million phones shipped internationally in Q1. Apple had 15%. If you only count the USA Apple had 37% with Samsung at 29%. Amazon is not going to suddenly gain a large percentage of the market. If they are lucky they may gain 2-3% over the first year but they have a lot of competition from Microsoft, Nokia and the dozen or more Asian competitors.

Amazon is hopeful that phone users will take a picture of a product in a store and then instantly buy it on Amazon. That would be the best outcome for Amazon and they would be happy to give the phones away at cost if all the users would become Amazon buyers.

With all the Amazon products the one they make the most money with is rarely heard. This is their cloud services division. They sell space on their servers to anyone with a very low entry fee as in FREE. Once you get hooked and start adding additional servers, memory capacity, processors, etc the free price becomes a monthly commitment that grows and grows and grows. Now Amazon Web Services has FIVE times the COMBINED computing capacity of the next 14 service providers according to Gartner Group. Five times the next 14 providers. The amount of scale is unbelievable. Some analysts expect Amazon to eventually sell more in annual cloud services than they will in retail merchandise. They sold $41 billion in retail products in North America alone in 2013. The average person does not have a clue how big Amazon really is.

SunTrust Mortgage (STI) agreed to pay $968 million to settle a federal probe into improper mortgage originations. SunTrust is the seventh largest mortgage originator. The settlement also covers 49 attorneys general so they will not have to worry about a new problem cropping up at the state level. In the settlement the bank said it improperly originated loans in the 2006-2012 period where loans did not have the proper documentation or verifications. Basically SunTrust wrote loans to anyone who applied just like every other mortgage bank. STI has previously set aside $1.2 billion to resolve the legal issues. Five other banks paid $25 billion to settle similar allegations in 2012.

SolarCity (SCTY) caught fire today after they agreed to buy Silevo for up to $350 million. The purchase price is $200 million plus an additional $150 million upon achievement of certain milestones. Silevo manufactures solar panels. Last week the Commerce Department announced tariffs on solar panels made in China and SolarCity gets their panels from China. CEO Elon Musk said the move was to gain control over their own panel costs and to manufacture them to fit SolarCity applications.

Musk said despite the excess of panels in the market today, with the majority coming from China, there is still a shortage of quality "unsubsidized" high efficiency panels to compete with the fossil fuel energy supplied by gas and coal. The Chinese tariffs would raise panel prices from 72 cents per watt to more than 80 cents. Musk said the majority of the excess panels on the market are low efficiency. Silevo has a manufacturing plant in China. However, they have plans underway to build a larger plant in New York using the proven manufacturing techniques they developed in China. With the SolarCity buyout the plant is expected to be upsized. Musk said "our intent is to combine what we believe is fundamentally the best photovoltaic technology with massive economies of scale to achieve a breakthrough in the cost of solar power. At a targeted capacity of more than 1 gigawatt within the next two years, it will be one of the single largest solar-panel production plants in the world. This will be followed in subsequent years by one or more significantly larger plants at an order of magnitude greater annual production capacity."

Some analysts called this the "Tesla-zation" of SolarCity. Tesla is taking control of their battery supply by building a $5 billion giga-factory. Now Musk is putting SolarCity in charge of making their own panels and being in charge of their own destiny by constructing multiple giga-factories for solar panels. If anyone can make this project it is Elon Musk.

Flash memory maker Fusion-IO (FIO) got a flash deal from SanDisk (SNDK) on Monday. Sandisk offered to buy FIO for $1.1 billion in cash and the deal is likely to close in Q3. Fussion-IO makes flash memory solutions for PCs using the PCI-e interface. It is a really high dollar, high performance product for users that need lots of fast memory rather than waiting on a slow disk drive. The PCIe-based SSDs are in high demand for online transaction processing and data warehousing.

The announcement was on Monday but SNDK shares not only spiked on the news on Monday but again today. The street really likes this deal.

Adobe (ADBE) reported earnings after the bell and the stock rocketed from $67.50 to $74 on the news. Net income rose +16% to $88.5 million or 17 cents per share. Excluding one-time items the earnings rose to 37 cents and analysts were looking for 30 cents. Revenue rose +6% to $1.07 and analysts were looking for $1.03 billion. Adobe said it had 2.3 million paid Creative Cloud subscribers, up from 464,000 just three months ago.

For the current quarter Adobe projected earnings of 22-28 cents and analysts were expecting 27. While that forecast was weak apparently the other metrics made up for it.

American Airlines (AAL) said it was cutting flights to Venezuela because the country is holding $750 million in revenue and won't release the funds because of the country's financial problems. American said starting July 2nd it was cutting flights from 48 per week to only 10. They will only fly from Miami and they are dropping the existing flights from New York, Dallas and San Juan, Puerto Rico.

The International Air Transport Association, a trade group for major world airlines, said Venezuela is holding $4 billion in airline money because of the currency problems. The government gets to say what companies get to use dollars and for what reason. Apparently airfares are not an approved reason. The government tries to force companies to use the local currency but the exchange rate is so bad it does not work. Air Canada and Air Alitalia have suspended all flights and Panama's Copa has reduced services. Several other U.S. airlines have also restricted flights because the government won't release their money.

Last month the government let six Latin American airlines repatriate revenue from 2012 and 2013. Otherwise Venezuela would barely have any service today. Airlines from America are not likely to get any money soon. America is the great satan according to the late Hugo Chavez and his successor Maduro is keeping the tradition going by refusing to pay American companies operating in Venezuela. Several oil companies have already pulled out and some of their rigs were nationalized by Maduro, meaning they no longer belong to the companies and cannot be removed from Venezuela.

AAL shares rose +2% on the news.

You probably won't be surprised to learn that the war in Iraq is still in progress. The battle between Sunni and Shia has been ongoing for 1,300 years so it is not likely to end soon. The U.S. said it was sending 275 soldiers to Iraq to protect the embassies. The Iraq embassy has more than 5,000 employees and it is the largest in the world. With the ISIS only 40 miles away from Baghdad today I am sure those employees are getting nervous. However, Baghdad is now an armed Shia city and the potential for the ISIS to take it over is practically nonexistent. The biggest threat to Baghdad now is car bombs as a demoralizing weapon.

The price of crude oil peaked at $107 as I expected because the potential impact to Iraq's crude production is very small. The slide in crude prices and the lack of any major headlines out of Iraq took the weight off the equity markets. I predicted the headlines would have little impact on the markets this week because it is now old news.

Despite the Fed's sleeping potion that has removed nearly all volatility from the equity markets the indexes sleepwalked a little higher today. The S&P traded in a 10 point range to close at 1,942 and -1 point below the intraday high. The extremely low volatility on the S&P is the worst in 35 years. It has gained only 12 points in the last three days and remains -9 points below its historic high close at 1,951.

That lack of volatility could disappear on Wednesday afternoon as Yellen speaks. There is a very good possibility her press conference could send the markets in a sprint in either direction or both. The post announcement direction is normally a head fake. After a few minutes the indexes normally reverse and head off in the opposite direction. The following day is also known as a reversal day after the analysts have all night to post their ideas on what the Fed really said and how it will impact the market.

The S&P has support at 1,925 and resistance at 1,951 and the odds are very good we will touch one of those numbers this week.

The Dow is slowly edging higher as it tries to shake off that huge bout of profit taking from last week. The spike was out of context with the prior gains and was begging to be sold. That consolidation appears to be fading and the index is slowly retaking the lost ground.

The various Dow components have turned mixed after a strong majority were positive over the last four months. The Dow is moving higher but it is on the back of a few strong gains and it is not broad based. That could easily change but it suggests some investors are still lightening the load for the summer.

The Dow is a long way from the resistance highs at 16,970 with initial support at 16,700.

The Nasdaq Composite returned to the scene of the crime today with the retest of resistance at 4,344. This time the index did not recoil as a result but hugged that resistance level the rest of the day. The small -7 point drop at the close was profit taking from the lack of a breakout. Astute investors saw the stall and facing the FOMC on Wednesday they cashed in a few chips.

I view the decent gain and minimal selling on the resistance touch as bullish.

The Russell 2000 rallied nearly a full percent to also touch strong resistance at 1,180 without a material decline after it was reached. I view the strong performance by the Russell and the Nasdaq as very positive for market sentiment. If the Russell were to move over 1,180 I think it would cause significant short covering.

Wednesday is sure to be a pivotal day in the markets. We can only hope that Janet Yellen continues her Empress of the Doves imitation and the market is pleased. She will have a tight rope to walk and her inexperience in FOMC press conferences has gotten her into trouble before. Let's hope she is at home practicing right now.

The market should go directional by next week. The FOMC uncertainty will be over and the headlines from Iraq should continue to diminish. Unfortunately, the week after the June expiration has been down for 21 of the last 25 years. While it may or may not happen again in 2014 we should plan accordingly.

As I said last week I believe we are in "buy the dip" mode until proven wrong. After the FOMC events there may be no headlines on the horizon to push the market in either direction but the ones that count are never expected as we saw with Iraq. We are headed into the summer doldrums season so try not to overload your accounts with longs. Summer corrections can be ugly. However, summer rallies are always unexpected and the short squeezes on low volume are always fun.

Enter passively, exit aggressively!

Jim Brown

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