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Rate Cuts Matter


The somewhat hidden catalyst for the economy will be the action of other central bankers.

Rate Cuts Matter -- but they don't work in a straight line. Meanwhile, monthly economic indicators will likely be erratic and trend less for a few months.

Interesting market today with the economic releases coming in very poor – I wasn't surprised, why was the market? January activity fell off a cliff and you had to be under the economic rock not to see this. However, the economy is a lot like the market, it usually doesn't bottom in a nice smooth predictable fashion. Additionally, you have had just about every major public and private company in the world waiting for more meaningful Fed action since the Fed's 25 bps OPUD (over promise under deliver), move in December. Last week's 50-basis-point rate cut by the Fed was hoped for, and the fact that it delivered on that hope (on top of the 75 bps emergency move), is going to restore some stalled business activity.

Negative Beta Still Lingers

Meanwhile, some disasters included, the tech sector has put in the best EPS results so far. This is especially true considering guidance for next quarter, whereas many other companies across the landscape are throwing the baby, the bathwater and sometimes the kitchen sink along with their guidance. The Dow Jones industrial Average closed the week 4.4% higher, while the Nasdaq Composite Index gained 3.7%. Year-to-date, the Nasdaq index is off 9% and the S&P is 5% lower. Again, these numbers are backwards and don't reflect fundamentals -- they just reflect Beta. I think we will begin to see a broad unwind of the negative Beta trade over the coming weeks.

Sentiment Could Be Approaching Turning Point

From my view, we are seeing a shift in negative sentiment, basically erratic peaking type behavior. This could be broadly good news for the bulls, but today and the next couple days' action will be a good test to see if we get some rounds of occasional dip buying. What I mean by this isn't a full on, market turning from negative to green, but some good bursts of buying that come in on selected stocks. This would also signify solid bottoming action. The Federal Reserve's aggressive rate cuts of late will help, though they still may be behind the curve. However, the amount they are behind has been drastically reduced.

Fed Restrictive Nightmare Gone, But Still Restrictive

Bottom line on the Fed is that they have gone from providing a nightmarish backdrop to taking the right steps, and I for one am simply hoping for less Fed induced market moves in either direction. I would love a return to what I will call "the no Fed zone". This is where we can trade on economic and corporate fundamentals and good research tends to be rewarded. Good corporate performance and/or valuation tend to get reflected as well.

So we still have 2-year T-Notes at about 2% versus Fed funds at 3% and the Fed has stubbornly held onto their discount window penalty. This really needs to go away, but as I previously outlined for 2008, we may be nearing an end to "being data dependent", as well as the flawed "inflation comfort zone". More rate cuts are needed in the months ahead. But I still think if they attacked the discount window that would reduce to total amount of cutting needed and loosen money where it is the most "stuck". The somewhat hidden catalyst will be the action of other central bankers. We get the ECB to lower rates by 100 bps and maybe we can stop.

Nirvana Signals Potentially on Horizon

The optimal scenario could have a chance to play out. This would be a more mild slowdown, a faster unwind of the stubborn commodity bubble, China not collapsing after their Summer games and concerted Central bank action to hold rates lower for a bit longer. Australia is doing their part in all this as well by trying to cool essentially a commodity driven economy down under. Globally, the Central banks could hold lower rates longer if inflation is only in embedded in the bowels of commodity push inflation (as I contend). Once the China Olympiad unfolds we will really see how much infrastructure building will be sustained. The Central banks may in fact need to keep rates lower to help spur the Chinese economy through a potentially rough patch later this year.

Technical Action

As for today, I like this action as it looks very much as it looks like healthy selling and digestion after last weeks big move higher. The worst thing for the sustainability of this emerging rally is an abundance of optimism, causing prices to recover much too quickly. I want to see a rally build steam and then when it breaks through various technical resistance points we have that much more momentum post break-out.

The S&P is being sold hard into every surge close to 1,400. When we finally get the move through and then beyond the next level which is right around the 1445 level, I believe the old highs could possibly be taken out. The ultimate new highs will hopefully depend on fundamental business activity and not further Fed action (like raising rates too quickly).

The Nasdaq has more cross currents and frankly I don't view the technical picture as important as the S&P, though it still is. Looks to me that the 2,450 level is a good benchmark level to clear (especially on weekly close), before really feeling that the lows put in a couple weeks ago end up being the lows for this cycle.

The good news is that the Naz has held pretty well of late even considering the scheming in most of the large-cap tech names during the past couple weeks. We also put up some good days with both Google (GOOG) and Microsoft (MSFT) posting losses. That would not have been possible in early January or late December. Post EPS trading action on these names has been flat out bearish. MSFT was one of the few big winners and now it's selling off from their merger announcement. So this says that the A/D ratios are improving a little bit and some stocks are refusing to go a lot lower.

Portfolio Action

So all the market Vol's lead to a lot of opportunity for longer-term stock picking at what could be multi-decade type values, opportunistic trading, and premium collection from options. I'm employing all of the above, not to mention the use of stops on losses and gains(trailing stop). Last week I moved trailing stops up on all my recent finance positions and everyone got hit. While frustrating for a few hours on Friday, those stops are serving me very well today as many of those names are down 10% or more from those stop levels. I still view the finance stocks as having historic upside opportunity but the road traveled could be bone jarring at times.

In Summary

The rate actions matter and matter a lot, as does the action from other central bankers, the multitude of earnings reports over the next couple quarters, global economic reports, sentiment and political issues. However, the nightmare of a highly restrictive/inflation comfort zone/data dependent Fed is behind us -- and I suspect the multitude of leading public and private companies now feel the same way.
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Positions in MSFT, GOOG

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