Weighing the Week Ahead: The Fed Takes Center Stage
Last week's trading was an upside surprise for most, including our trading models. The risks were evident to all, but there seemed to be a change in tone. Our indicators are still bearish for the three-week time horizon, but it is a confusing and challenging picture. I would not be surprised to see a mid-week shift if technical levels hold.
The Fed Surprise
In my analysis and forecast last week, I did not expect the Fed to play a major role. We were sitting at our conference table at a meeting Thursday afternoon, CNBC on mute and TIVO on as usual. Olympic curling was scheduled in a short time.
The financial world has renewed its interest in curling from four years ago during the Winter Olympics and the CNBC coverage. All of a sudden, the financial punditry includes many experts on last end strategy, when to employ blocking stones, and whether the US team needs to replace Skip John Shuster (pictured below).
To everyone's surprise, the Fed announced an increase in the discount rate. The after-hours financial trading was a knee-jerk selling reaction. In a way this was pretty silly, and typical of what can happen in the thin, late afternoon market. Actually, in a strange way, it made sense. News breaks. Is it positive or negative. This was certainly not positive. There is an instant reaction to sell.
To my surprise, the confusion lasted into the next day. There were many stories about what happens at the start of a Fed tightening cycle. Wow! There are two things wrong with that analysis:
- This was not tightening. It was a technical move intended to restore the differential between the discount rate and the fed funds rate.
- Reducing policy accommodation and tightening rates are different — very different, as I showed in this article.
In response to the financial crisis the Fed has employed a wide variety of unusual measures. As economic conditions improve, these measure will be reduced and withdrawn.
Those who can monitor the Fed accurately, dispassionately, and without bias will be the best placed to evaluate these consequences. Since this requirement excludes 95% of the investing punditry, it offers an opportunity to the thoughtful and informed investor.
Or you can use the same skill you have in following curling to follow the Fed. The biggest mistake would be the mis-application of the old saw, "Don't Fight the Fed."
Last Week's Action
Let's start with a look at
the key data from last week. As usual, I am not trying to be
comprehensive, nor am I taking a viewpoint. I will highlight what I
Earnings season is finishing up on a very strong note. Barron's reported the facts while also emphasizing the bearish interpretation:
Nearly 68% of companies reported fourth-quarter profits that beat
estimates, while 71% topped revenue targets. Companies raising
Deere (DE) and Whole
Foods (WFMI) did last week, outpaced those cutting by
2-to-1. Yet investors are more concerned about how profits will hold up
as interest rates and taxes inevitably rise.
Bespoke Investment Group is more balanced in the earnings assessment. They note that bearish pundits have dismissed strong earnings in recent quarters as the result of cost-cutting. This quarter was different, with an exceptional revenue "beat rate." BIG asks, "Does this put the "strong bottom line, but weak top line" bearish
argument to rest?" Here is their chart, but go the article for more of their great graphics:
The CPI news showed a decline in the core rate, the indicator most relevant to Fed policy. Policy will remain focused on the threat of economic weakness, not inflation.
Housing starts were OK as were permits, two of the indicators we cited last week. Industrial production was a bit better than expected.
There was plenty of discussion about the one-year anniversary of the stimulus package, and the effects so far. This is a complex story in a highly-charged political debate. I'll take a closer look soon.
The continuing jobless claims were weak, despite weather that many thought would impede new claimants. The inputs for our payroll employment model are also quite weak. In addition, some believe that the weather will reduce reported jobs for February, since the survey week included the worst of the weather.
The other bad news came from surprising sources. Two different studies emphasized the continuing rate of mortgage defaults and the resulting increase in "shadow inventory." The definition and analysis of shadow inventory remains murky, and no one discusses shadow demand. The analysis of the housing market would benefit from the involvement of some real economists with no economic or personal agenda.
The situation in Greece has not improved nor has it gotten worse. The stock market continues to trade higher when the dollar is weaker.
The Week Ahead
Next week will have a political focus. The new jobs bill is up for a Senate vote on Monday and prospects are not good.
Fed Chair Bernanke will testify on Wednesday and Thursday in the semi-annual "Humphrey-Hawkins" testimony. I doubt that there is anything new to say, but there will be some tough questions, especially from Ron Paul in the House and Jim Bunning in the Senate. Any discussion of exit strategy is unlikely to have a bullish result.
There will be a health care "bipartisan" meeting on Thursday. I am not optimistic about this either.
The economic news includes plenty of information on housing: Case-Shiller pricing data on Tuesday, FHFA data on Thursday, as well as new home sales on Friday. Housing is crucial right now, so all of these stories will be important.
Thursday's jobless claims and Friday's Chicago PMI also have the potential to move the markets.
To summarize, it is an interesting week with plenty of news on tap. It is difficult to predict, especially when the key indexes are all near key technical levels.
Our Trading Forecast
- Only 11% (down from 67% three weeks ago) of our ETF's have positive
ratings. This is extremely weak.
- The median strength is -27 (down from -22 last week), very negative.
- 95% (up from 35% three weeks ago) of the sectors are in the "penalty
showing an extremely high level of risk.
- Our Index Package has a negative rating. We own SH, PSQ, and DOG, the
inverse ETF's for the S&P 500, the NASDAQ 100, and the DJIA.
A Final Insight
I noted in my preview for this year that I would be watching for a chance to buy health care names. Some of my choices have already caught upgrades and moved nicely. This week's health care debate will provide one more chance for a dip in some names. I am watching the service providers, recently under some pressure.