MASTERING
THE TRADE
ORIGINAL, INTERACTIVE SEMINAR ON TRADING USING
TECHNICAL ANALYSIS 

 SEC FILINGS

Technology remained the toast of the town and the leader of the pack as tech stocks continued to benefit from a belief that the sector would be the main beneficiary of a global economy growing in unison. 

The IPO market, left for dead last month, sprang back to life as Ask Jeeves quadrupled on its first day of trading.  The renewed interest in IPO's is a strong signal that sentiment has returned to its pre rate hike jitter levels.   The full recovery in investor sentiment is also evident in the latest figures from AMG Data, which showed $6.2 billion pouring into equity funds in the latest week, with 55% of that going into growth funds.  Investors are once again rushing to put money into "the only sure fire winning game in town".  This liquidity driven exuberance will act as a powerful short term safety net for the market, cushioning the initial blows to the prevailing wisdom and trend that inevitably occur when sentiment reaches an extreme.

The recovery in sentiment means that the glass is once again seen as half full, rather than half empty.  In an environment where the glass is seen as half full investors are only able to see the positive events that will impact the future, while the negative events are cast aside or overlooked.  This narrow focus on only the events that will reinforce one's belief in the prevailing trend inevitably leads to divergences between the actual environment and the perceived environment.

We saw these divergences at work yesterday as the stock market was able to look on the bright side of things and cast aside a stronger than expected NAPM report and move higher on the belief that the future interest rate environment would be benign, while at the same time  bond market sentiment was sinking on the very same report. This morning, after an initial 6 point drop in the S&P Futures, traders quickly shrugged off the news of higher than expected gains in average hourly earnings and non-farm payrolls, and instead focused their attention on the rosy outlook for corporate earnings. The prevailing sentiment had once again provided a safety net.

Striding into the sunlight of the New Paradigm they had temporarily abandoned during their month of torment, the 12 noticed a perceptible change in the air: where before hung scowls now hung smiles.   Their friends had returned, and the makeover was a smashing success! The bond traders who had whispered curses about the 12 only yesterday now cheered them on with grateful chants of "FOMC, 1/4 point hike, you've retained your credibility!".   With tensions gone, order restored, and memories of the Pre-emptive Crusaders fast disappearing, all was well again, and all lived happily ever after in a land where rate hikes were no more...

...or at least that's the consensus version of the story.   We have a different take on yesterday's events.

The move to a neutral bias is not a signal by the Fed that it is done tightening, it is merely the FOMC's way of saying, "present conditions do not warrant a further move before the next meeting in August".  The FOMC has followed every rate hike this decade with a move to a neutral bias, but the adoption of a neutral bias has not precluded further rate hikes, quite the contrary.  The FOMC's move yesterday was merely designed to reassure the markets that it has no intention of hiking rates in the interim before its next meeting--unless economic data warrants a hike before the August FOMC.

With consumer confidence hitting a new high in June and stock market complacency rising in step with it, the FOMC erred yesterday in sending out a signal that will only add fuel to the fires of wealth effect created  economic imbalances that are building in the economy.  The market, unchained from its recent jitters by yesterday's action and with earnings season just ahead to add further fuel to the market's predisposition to soar, will now rally and with that rally will come a further increase in the desire of consumers to spend beyond their means.

The Fed's unleashing of the restraints on the market yesterday means that domestic demand will continue to soar, and with that rise the prospects of the economy encountering inflationary pressures will be that much greater.   The Fed's change to a neutral stance has increased the chances that its future action will have to be more drastic to tame building imbalances before the imbalances put an end to the present economic expansion.

With bullish sentiment about the future at extreme levels, and with many traders unprepared for the unexpected, we would use extreme caution when approaching the U.S. market in the coming months.  The market is likely to stage a summer rally before the next Fed meeting, but the slightest disappointment on either the earnings or economic data fronts could quickly prick the bubble of optimism which has built in the wake of the Fed's move.

The Fed's month long attempt to curb the stock market's speculative excesses with an injection of rate hike fear has ultimately proven to be a futile exercise.  The market's historically high valuations stood their ground against the specter of rising bond yields and an imminent hike by the Fed.  The NASDAQ 100 enters today at a new high, and the S&P 500 and NASDAQ Composite are within striking distance of new records.

The stock market's resilience in the face of today's expected 1/4 point hike has increased the likelihood that today's hike will be followed by a series of 1/4 point moves as the Fed tries to prevent the economy driving wealth effect from turning the New Era into a repeat of 1989 Japan.

Today's hike will be merely an attempt by the Fed to retain credibility with the bond market.  It will have little effect on the free spending, debt accumulating consumer. With complacency in firm control of the market, the Fed will be forced to act several more times before the consumer's urge to splurge is reined in.  Current excesses in bullish sentiment leave the market unprepared for the eventual effects of the Fed's moves.

Following the runup by the major averages on Monday and Tuesday, today's Fed announcement is likely to be a case of buy on the rumor, sell on the news, but any market movement is likely to be short lived as traders quickly move on to the next sets of economic data: the NAPM and the Employment report.

The few who did arise were a fearless lot, snapping up shares left and right without a rate hike jitter in sight, and with the most speculative of shares the most highly sought out at the day's close.

The lack of fear present in the market yesterday, and the corresponding rise in complacency, is not what we would like to see ahead of a Fed meeting.  While it is true that many fear ridden souls are sitting on the sidelines until the Fed's decision, the degree of complacency in the market is creating a dangerous situation in which the slightest jolt to the prevailing wisdom will produce a swift decline. 

Yesterday's equity put/call ratio of .36, and index put/call ratio of .76 are especially troubling in the face of a looming Fed meeting, and this week's NAPM and Employment reports. The belief held by many that the worst will soon be over, and that a stellar earnings season will mitigate any of the remaining danger, is misplaced in our view.

The market's focus on the present, and inability to focus on the conditions that will breed the future, are creating a situation in which the eventual disappointment will be that much greater when the cycle turns.

Yesterday's personal income and consumption figures did show that present inflation remains under lock and key, with the key inflation gauge the Implicit Price Deflator flat for the month, but yesterday's data also showed worrying signs that the forces that can bring about future inflationary pressures are gathering steam.  This year's rise in bond yields has not slowed the consumer, who remains on a buying binge that is  accelerating even as interests rates rise.

Short term sentiment, the sound byte grabbing stuff of which The Jitters and the Nagging Doubts are made, continued to deteriorate Friday afternoon as the few remaining traders in the city were subjected to wave upon wave of sentiment denting missiles from their archenemy, the  Looming FOMC.

The two tier nature of current market sentiment, a short term mood which influences the day to day, and a deeply ingrained long term positive mood which acts as a market safety net, should be remembered as this week's moment of truth, the FOMC, approaches.

The outcome of this week's FOMC is unlikely to do any damage to the market's deep affection for equities which has been built up over the past 17 years--that will take time.  This long term affinity to the present trend will act as a safety net for the major averages in the event the Fed springs a surprise. "Buy on the dip", and "bargain hunting" will continue to cushion the market against trend ending falls in the short term, but we expect the public's faith in the trend to be put to the test as interest rate uncertainty continues to grip the market as the summer progresses.

The long term faith in a never ending uptrend will not suffer any serious damage as long as the market remains above 9200-9300.  Below these levels,  cracks would start to appear in the resolve of investors to stay the course, and with the deepening of these cracks would appear the inevitable change in the market's long term trend.

While the market's long term trend will still be intact after Wednesday's rate decision, the short term's next move will be held hostage to the FOMC's actions.  In the short term, the most likely scenario: a 1/4 point cut with no change in bias will produce a powerful relief rally that will soon succumb to the Nagging Doubts. 

Of the other scenarios the market is faced with this week, the ones to be feared the most are a 1/4 point hike with a change to a neutral bias, or no action by the Fed at all--either one of which would be met with a swift bond market selloff as traders quickly lost faith in the Fed's credibility.