The Fed Fade Continues: Homebuilders and Retailers

By Dr. Duru written for One-Twenty

September 21, 2007

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The signs of a Fed fade continue. Amazing what you find when you look for it. On Wednesday, we had Morgan Stanley (MS) give up its Fed gift after earnings. And the selling continued on Thursday to bring MS not only below the low of the Fed day, but even below where it opened for the week. Let's call that fully faded. BSC faded before its earnings and the actual earnings news appeared to be a non-event. The stock ended flat on news that included an increased buyback. And just like LEH and MS before, BSC insisted that "...the worst is largely behind us. We've marked positions down, reduced risk and freed up balance sheet capacity" (as reported by Goldman Sachs (GS) was the belle of the ball by reporting what WSJ indicated was GS's 2nd-best quarter ever! GS even made good money from various financial bets against mortgages. GS ended down for the day but it still stands firm for post-Fed trading. If the market goes where the investment banks go, then the case for a post-Fed fade continues to build.

Even if the market somehow avoids giving 100% of the post-Fed pop back, we should take careful note that two important consumer-related sectors have already faded: homebuilders and retailers. As represented by the related ETFs, homebuilders have completely wiped out Tuesday's gains and even look posied to resume their ugly downtrends as volume has surged to the downside. The retailers are clinging to a small portion of Tuesday's gains, but they have traded back to prices immediately following the Fed announcement.

mini XHB-chart mini RTH-chart

So, it appears the Fed's action has provided a psychological boost to the overall stock market as represented by the major indices. But the Fed's action may have less of an impact where it is really needed: homebuilding, retail, and perhaps even financials. RKH, the ETF for regional banks, has just about faded its post-Fed pop. The Fed claimed to cut rates to prevent the recession in housing from dragging down the rest of the economy, but what happens if housing continues to get worse? It might be a good thing that we are about to enter the seasonally slow period for home sales since that means there is less potential downside for now!

It is still very possible, even likely, that we get bounces once the Fed fade is complete. Such a bounce would indicate readiness to continue moving higher. And looking past the seasonally weak period of September and October, I am remaining optimistic, at least for stock prices. If nothing else, history suggests that the big pop we got in trading the day after Labor Day suggests that the year will end on a positive note. Moreover, the big investment banks have essentially told us that the market's self-healing process started even before the Fed cut rates. When we look around at the hot stocks of the week, we see energy, commodities, some tech, and a lot of China ripping to 52-week highs. Liquidity is still being put to use. Finally, volatility looks ready to come down to lower levels, and August's big swoon is looking more and more like a short-term top in volatility and probably longer-term bottom in stock prices.


I will continue to watch the behavior of trading in the four horseman from this week - LEH, MS, BSC, and GS - to get my clues for what the immediate future may hold. The market did very well in running up in anticipation of "not so bad" news from these financial powerhouses. Future trading should also provide good indicators. In the meantime, be careful out there!

DR. DURU®, 2007