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Oh goodie - Fed Day...



As my car pool buddy Linda and I drove into work today, our normal vibrant conversation was interupted a few times by economists on the radio commenting on the whether the Federal Reserve will cut short-term interest rates or change their policy bias today at the FOMC meeting. It seems that the consensus expectation is for no change in rates right now, but many expect a comment that risks are weighted toward economic weakness.

The truth of the matter is that rates should be low enough already to spark economic growth. Should there be yet another rate cut -- from an already historic low of 1.25% Fed Funds Rate -- my takeaway would be that the Fed is getting even more concerned about deflationary pressures. Even debating this far into an economic recovery whether the Fed should cut rates or not is saying something on the topic of "hope" vs. "reality."

Since March 11, the market has traded to the upper end of the range on the hope that once the war with Iraq ended there would be a large uptick in spending making economic and earnings forecasts for the rest of the year move dramatically higher. As you know, the market trades up on the hope, but either stays up or falls back on reality. It has been a long time since the reality has been good enough to cause the market to keep going higher after a significant move off the low. I would consider a 15.7% rally in the S&P 500 in two months a pretty good move.

At this juncture, I believe it is very important to look what we have directly in front of the financial markets.

· The dollar is getting creamed. While that doesn't necessarily mean stocks have to follow suit, it certainly doesn't auger well for foreign money flowing to U.S. financial assets over the very near-term.

· The improvement in the corporate debt picture (credit spreads) has probably taken the "worst case" scenario out of the markets for now, but if Warren Buffett (by media accounts) is telling investors not to chase high-yield debt despite the still wider than normal spreads, it is probably a good time to pay attention. Not because he is Warren Buffett, but because he was a money manager who almost perfectly timed the high-yield entry point. Just because something isn't priced like it is going bankrupt anymore doesn't mean it is a bullish sign.
· The war gave the economy and corporate America a "free pass" for bad news. In other words, the government or any corporate head could blame the war for any weakness. That excuse is no longer valid. Now, for stocks to break through to the upside, the news has to actually get much better.

· In a market of extreme opinions, the correct view is probably that volatility will continue to shrink and stocks won't break through in sustainable way to the upside or downside, but will remain stuck in a range that frustrates both the bulls and bears. The markets are not cheap, corporate debt isn't way out of whack, economic and earnings growth are moderate at best. In other words, the fundamental backdrop has moved back toward a neutral area vs. being overly depressed. Nothing really seems way out of whack right now, which serves to reinforce the wide trading range environment.

· If a new bull market were beginning, there would be significant signs in sector leadership. Right now, all the sectors are hitting against upside resistance in the context of a trading range. The only two sectors that look good and are not at resistance are rallying because they no longer look like they are going to zero -- Information Technology and Telecommunications. As I said, this is not bearish, but I would like to see the various sectors breaking out to indicate the market as a whole was poised to break out of the range. It could still happen, but has yet to.

The bottom line is that this is a critical juncture because the market as a whole is into overhead resistance and is overbought. If it is going to break through in a sustainable way, the news flow should begin getting dramatically better. Suggesting the Fed needs to cut rates now doesn't give me a lot of confidence that better news is imminent. The one thing I do know is that better news will be reported by the market action before any media outlets or Wall Street brokerage houses.

My "hope" is that Daisy loves me...the "reality" is that she is a metaphorical cow in Toddo's head. I guess there is a difference between the two!
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