Get Ready to Rally - Sort Of

By Dr. Duru written for One-Twenty

June 15, 2006

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I could hardly believe my eyes. The S&P-500 finally made what looked like to me a true burst of buying. As I scanned other indices, I saw similar patterns - the buyers all stepped up in unison as if to say "enough is enough already." TraderMike does another good review of the technical landscape, and it confirms what my "gut" was telling me after I observed the strong closing action. Lots of people have been looking for some kind of blow-out move or capitulation to signal the end of the selling. This month-long correction has featured a few moments that seemed to be candidates of just such a bottom, but they all failed. Instead, what we might get is an "absence of selling" that marks some kind of bottom. It would be the kind of move featuring agile shorts locking in profits and getting ready to reload for the next test of resistance.

Note that I must temper my enthusiasm over a potential bottom. As I have mentioned in earlier missives, the Fed has made it clear it is against us. We are fighting against a vortex that exists specifically to drain liquidity from your pockets. There was also no real positive catalyst that supported Wednesday's late-day surge (although I am sure the mass media will find something.) Inflation numbers this week were just as bad, and even a tad worse, than economists expected. When we got the exact kind of reading in May, the market panicked. This time, the market just held ground. This tells us that the market has just about factored in all the negative news. If you have not already sold, it is "too late" now. We will have a quasi-vacuum until the Fed meets at the end of the month. In other words, the news could not possible get worse now, right? The Fed futures I believe are now printing a near 100% chance of a Fed hike. We cannot get much higher than that. I think we have now heard just about every meaningful member of the Fed yap away about how serious the Fed is about fighting inflation, including a Fed member ringing the same alarm bells during Wednesday's trading. We have now heard a steady drumbeat of alarm about the unwelcome upticks in inflation readings. Frankly, it seems like the market has finally gotten tired of it (just as much as I have!). Maybe even starting to get numb to it. Heck, even gold, which is supposed to be an asset for hedging against inflation and other financial calamities, has now sold back down to the top of the trading range from earlier this year. Besides, who else is left to cry wolf? I do not mean to make light of the potential risks of inflation, but, as I stated in the last missive, I think the Fed is the last one to "hear" the news about inflation. Even worse, the biggest sources of inflation that matter the most to a lot of consumers - health care, gas, education - will be little effected by the Fed's presumed hawkish behavior. Health care's climbing costs have little to do with economic activity. Gas remains high because of perceived and real risks to supply. Education has been racing ahead of inflation for a while now, and we never get any sympathy from the Fed on that one.

Anyway, for a reminder on the Fed's attitude, check out Governor Susan Schmidt Bies's comments on Wednesday. Right after she acknowledged the significant slowing in the pace of home sales, she quickly notes: "Although a slowdown in housing activity is apparent in a wide range of indicators, it seems to be occurring in a gradual way. Notwithstanding their recent slip, both home construction and home sales are still at relatively high levels. The underlying fundamentals of housing demand also remain favorable. Real disposable income is growing at a solid pace. In the aggregate, household balance sheets appear to be in a good position, even though risks clearly exist for some households. Long-term mortgage rates, although up substantially from last summer's level, remain low relative to their historical experience. The latest data on house prices from the Office of Federal Housing Enterprise Oversight suggest that house-price appreciation has moderated but that prices in the aggregate continue to move up." In other words, so what that homebuilder stocks are at multi-year lows, blah, blah, blah? We are still having it good compared to years past, and we could use a few more slices of interest rate hiking pie. The Fed is not at a point that it believes weakness and leverage in the housing sector poses any serious risk to the greater economy. If you are interested in the more technical aspects of what the Fed cares about when it comes to real estate markets, the rest of this speech may be of interest to you.

So, enjoy whatever rally we get while it lasts. Do not forget that almost every trader and investor worth his/her salt is staring hard at the exact same set of indicators that you are - or at least those folks not already closed down for summer chilling after selling in May. Lots of folks straining to see a bottom and lots of folks looking to sell on the next rally. This means you should not expect a counter-trend (and counter-news) rally to take things up in a straight-line. The bulls have been blinking first for a month. It will take some time to adjust those sore eyes to the light that seems the be at the end of the tunnel.

Be careful out there...! And I still say you should seriously consider those CD rates around 5%! While you're at it, enjoy some World Cup action...even if Nigeria did not make it this time around(=smiles=).

DrDuru, 2006