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This new leader, introduced by Greenspan & Co. on Tuesday, continued to hold sway over market participants yesterday and will likely dominate in the coming weeks, with the dangers increasing with the passing of time as an excess of sentiment in favor of the long dominant trend slowly dissipates. Uncertainty continued to pick up followers yesterday, and Euphoria continued its hasty retreat into the sunset on Thursday, with the Internet stocks feeling its loss the most.

Euphoria is one of three siblings: Euphoria, Gloom, and Uncertainty. The sentiment twins Euphoria and Gloom, while extreme in their behavior and frightening to those caught on the wrong side of them, are periods during which a profit is readily available to those who are aligned with them.

While Euphoria and Gloom capture the hearts and minds of investors and the press, it is Uncertainty which is the deadliest of the three siblings.   Uncertainty is the period between trends.  It is a period during which investors, while aware of the changes that lie ahead, are still partially hypnotized by the bright lights of the long resident but recently departed prevailing trend of yesterday.  It is during this period when investors, aware that a turn must be made but happy with the direction they have been traveling, often see the profits made during the previous run slowly whittled away as indecision slowly turns to regret.

The initial stage of the period of Uncertainty is a time when conflicting signals intertwine and compete for attention.  The old is juxtaposed with the new, with the competing forces of yesterday and tomorrow firing off a rapid succession of invitations to join their party.

The dangers faced by investors during periods of transition are greatly increased, and the ability of investors to prepare for the future is likewise greatly impaired, when outside forces have diverted the attention of investors from a focus on the future outlook to a focus on the day-to-day gyrations of the market.   The ability of a singular event to cause a mass exodus is greatly increased by this short term focus-- what would seem a minor event for someone with an eye to the future becomes a cataclysmic event to one focused on only the present (or on the recent past).

The long bond rallied 34/32 with the yield dropping to 5.80% as a combination of bargain hunting and short covering fueled a day long buying binge.   Lower rates lit a fire under the homebuilders and financial stocks, and Applied Material's better than expected results helped ease the pain of Dell's sliding margins in the tech sector.  The day's best performance was reserved for the interest rate sensitive utilities, which surged 5.42 to a new closing high of 324.25.  The advance/decline line also registered a solidly positive day, with advancers leading decliners by a 4 to 3 margin on the big Board, and by a better than 2 to 1 margin on NASDAQ.

Question: With a solid up day in both the stock and bond markets, what was there not to like?  Answer: The tech sector rally for starters.

Yesterday marked a continuation of the Muted Reaction to the Positive that we have noted over the past two weeks.  There has been a subtle shift in sentiment over the past few weeks.  In the recent past investors would have overlooked Dell's margins and concentrated on the positive, but now with euphoria ebbing, news is seen in a new light.  AMAT's strong earnings also failed to produce the powerful tech sector rally that the numbers would have produced a month ago--news that once would have sparked a 60 point NASDAQ rally now produces a 19 point rally.

The decline of euphoria poses no immediate danger to the market, but it does leave the market at risk if the unexpected should occur.   Underlying sentiment is still strong enough to hold the market aloft, but it has been weakened.

Yesterday's bond market rally also poses a double edged sword for the market. A one day rally is a nonevent, but if the rally were to continue in the coming weeks with yields dropping to 5.3%-5.35%, what at first glance would appear to be bullish for stocks could prove to be deadly.  The Fed announced a change in its bias because it wants the bond market to do its dirty work for it, if the bond market fails in its task and economic growth picks up again on the backs of falling 30-year yields, the Fed would be swift to act.

Apart from the stock and bond markets, we also have one eye on the dollar's recent rise against the yen and its potential implications for the profits of U.S. multinationals if the yen's weakness continues.

The long bond, which had largely priced a change of bias in already, gave back the 1/2 point it had gained following a weaker than expected housing starts report and ended the day down a tick, with yields remaining at 5.89%. Barring a repeat of last Friday's CPI surprise, 30-year yields will likely settle into a trading range between 5.73% and 5.98%.

The stock market's selloff went according to plan, with a sea of liquidity and eager weak hands cushioning the market's fall.  Factoring out the effects of an earnings related surge in Hewlett-Packard, the Dow turned in the day's worst performance.  We  expect the Dow's underperformance to continue in the near term.  Yesterday's Fed Shift will put a ceiling over the cyclicals and oils which had led the Dow in recent weeks.

The Dow's financial components will also hamper its performance in the coming weeks.  Investors in financial stocks were given a clear sell signal by Greenspan & Co. The divergence between the performance of traditional brokerage stocks and the overall market will likely widen, while banking issues will enter a phase of uneasy stability, waiting for the next bit of bad news before they too enter down trends.

The one exception to the financial sector underperformance that we expect will be the online brokers, which will retain their tulip like magnificence for a while longer as the market continues its traditional end of trend rotation from strong hands (institutional and insiders) to weak hands (retail).  The AmeriTrades and E*Trades of the world will offer the greatest downside potential of any industry when a final break occurs, but for now these stocks still have a little longer time left before they are forced to surrender their 15 minutes of fame.

Notable in yesterday's trading was Amazon.com, which gained 5 1/4 points after the company initiated a price war with rivals Borders.com and Barnesandnoble.com. Clearly we're out of step with the new math of the new paradigm, but when a company with widening losses cuts further into its margins by firing the opening salvoes in a price war, it does not seem like a prime buying opportunity to us. [NOTE: Investors will be given a chance to diversify their holdings in the narrow margin online book biz with next week's trading debut of Barnesandnoble.com].

Aside from Amazon, we were struck by a pair of occurrences in yesterday's trading which could prove to be slightly bullish for the market in this afternoon's post FOMC final hours.  One was the extreme negative sentiment expressed in the trading of Dow Industrial options yesterday on the CBOE, where 16,841 puts traded and only 3,719 calls.   The other was the performance of the Utilities, which gained 3.27 on the day.   Yesterday's outperformance by the Dow Utilities could indicate that a move towards a tighter bias has already largely been factored into the market, and a move by the Fed will be met with only limited losses in the long bond, with rates backing up only to resistance at 5.98%.

While we believe the chances of a Fed rate hike today are zero, the Fed will  be pulled in several directions today as it struggles to decide whether to adopt a bias towards tightening. The Fed will have to balance its need to remain vigilant against inflation with the needs of a still fragile global economy whose recovery is heavily dependent on a continuation of strong U.S. economic growth. The Fed must also decide whether last week's strong productivity numbers and tame PPI data were negated by Friday's CPI and Industrial Production numbers.

Perhaps more important than either of the two previous concerns, the Fed must also ensure that its reputation is preserved.  A failure by the Fed to change its bias would be taken by many bond traders as an indication that the Fed has fallen seriously behind in the war against inflation.  The possibility exists that the words, "No change in bias by the Fed", would be met with heavy selling by a disillusioned bond market.

The bad news is: who cares?

Friday's higher than expected Core CPI and Industrial Production readings have triggered a global sea of red this morning. Our short term readings have now turned negative for the S&P 500, NASDAQ, Hang Seng, Nikkei, and DAX. Our indicators are also flashing short and intermediate term sell signals for the FTSE 100 and for Milan's MIB30 .  With sell signals flashing on several fronts, we will be doing the sensible thing this morning: ignoring them (with the exception of one) for a day, hedging our positions, and waiting on Greenspan & Company.

The one indicator we are acting on today is the breakdown of the MIB30, where the Italian economy dictates that regardless of the Fed's decision tomorrow the index will see 25,000 long before it sees 40,000.  The DAX and FTSE have both seen their highs and are also headed much lower, but both indexes could enjoy one last bounce in the event the Fed stands still, and so we will wait until after the Fed's decision--just in case.

Which brings us to the Fed.  We said Friday that there will be no change in interest rates by the FOMC tomorrow, but that the odds had increased that the Fed would change its bias towards one of tightening.  In our view, the move towards a tightening bias could spell disaster.

In January we said the Fed needed to raise rates in order to prevent the overheating U.S. stock market and economy from repeating history, specifically the history of post bubble 1990's Japan.  Needless to say, the Fed didn't act and instead allowed the bubble to expand. A move by the Fed now, after the fact, would set off a chain reaction of global economic events that would make last October seem like a practice session.

U.S. economic growth at this point is entirely dependent on a continuation of the stock market's upward thrust--the self feeding circular wealth effect of a rising stock market feeding  consumers spending beyond their means who are feeding a consumer driven economy which is fueling a rising stock market.... The economic ponzi scheme of which we spoke in January has now been allowed to grow to such an extent that any pricking of the bubble would set off a self feeding destructive economic circle in the opposite direction that would drag other global economies down with it.

We have a sneaking suspicion that the Fed is aware that a change in policy at this point would have a profoundly negative effect on the economies of nations that are struggling to pull themselves back from the brink.  During tomorrow's meeting, we have a feeling that it will be Japan's fragile economy, rather than last Friday's CPI, that dictates the Fed's final decision.