Wait Until You See the Whites of Their Eyes

By Dr. Duru written for One-Twenty

January 3, 2006

Welcome to 2006. The Fed appears to have finally delivered some bona fide good news to the market...the end of interest rate hikes is near! The market's discounting mechanism went into high gear in response to this interpretation of the Fed minutes released today. However, after reading a few articles on the topic, I noticed a disturbing pattern - no one provided any specific quotes stating that the Fed said the end is really near. Well, you know one of my favorite hobbies is to actually read the Fed statements and minutes and come up with my own opinion (I know, I know, what a bizarre fascination!). Here are the three quotes that I found that seems to have gotten the market excited: 1) "Views differed on how much further tightening might be required...", 2) "The federal funds rate had been boosted substantially, and, in the view of some members, it was now likely within a broad range of values that might turn out to be consistent with output remaining close to potential.", and 3) "Although future action would depend on the incoming data, this characterization of the outlook for policy was seen by most members as indicating that, given the information now in hand, the number of additional firming steps required probably would not be large."

Hmmm....excuse me while I refuse not to get excited. Not only are these quotes far from a direct admission that the light is finally shining at the end of the tunnel, but the minutes go to great lengths to explain that tightening will continue as long as economic conditions warrant it. What I read is that as long as the economy remains relatively strong, energy prices remain high, and resource utilization remains robust, the Fed will likely continue to hike rates in response. Given their impressions and forecasts of the economy, we could still see rate hikes for the indefinite future, albeit perhaps no longer at every meeting. In other words, I refuse to get excited until I see "the whites of their eyes," and the Fed shows up with a conclusive statement that the hikes are over. In the meantime, I have no problem riding the current europhic wave, no matter how ephemeral, but you will not find me betting the farm on rate-sensitive sectors yet! I was very intrigued by what did NOT go up today in response: Catepillar stayed flat, Deere did the same. IBM bounced back from another decline but still finished in the red. I am sure there are company-specific issues at work here. But my point remains that we cannot assume even a rough timeframe for the end of the hikes, much less start predicting that rates will now start to come down.

In other news, the market is already slapping me with answers to questions I posed to close out 2005. Gold has NOT topped out. And to the extent the market believes the Fed is closer to the end than ever, gold should continue moving up in anticipation of further devaluation of the dollar. Housing stocks are not only making a last stand, but they are officially in short-killing mode now. Some of those bad boys popped 10% from bottom to top today (see TOL for example). The market is definitely ready to continue supporting steel even as a major consumer like GM continues to sink deeper into the abyss. GOOG is not stopping until infinity or somewhere therabouts. The news coming out of on-line advertising is flaming red hot, and Piper Jaffray upped the ante by slapping a 12-month $600 price target on GOOG - a 36% pop even from today's scorching close. The oil and gas sector came out the gates racing even as winter weather moderated around the country again. I think watching Russia play energy politics with its neighbors is making people realize (again) that the energy sector is far from dead. And as far as repeating the same fade we got in 2005? Well, so far, we are doing the exact opposite - even after the market quickly faded a nice pop in the opening.

My advice is that you should ride whatever wave of euphoria we get for all its worth...but do not believe in the architects until the designs actually get documented. That is when you will see the whites of their eyes.

As always, be careful out there!

DrDuru, 2006