Roll with the Bounce

By Dr. Duru written for One-Twenty

March 11, 2008

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Apparently, the Federal Reserve is an excellent technical analyst and market-timer. After the S&P 500 made three consecutive new closing 52-week lows, the index finally looked ready to crack the 52-week intra-day low. Sentiment was high-pitch bearish - although there was not an equivalent amount of fear - and shorts were pressing their bets home. Even the Dow Jones Industrials index was on the verge of confirming as false the break-out in 2006 to new all-time highs. By some measure, stocks were also getting oversold. I even just conceded defeat on my thesis that the U.S. economy would grow slow but would not contract into recession - I had gone from 95% to 100% bearish. It was at this time the Fed introduced a mortgage bail-out plan that has so far been widely hailed as innovative and even non-inflationary. The timing was perfect to generate maximum response as it caught a lot of shorts flat-footed and bulls clinging to the edges of defeat. The resulting short-covering and buying panic provided a monster rally: the S&P up an incredible 3.7% and the NASDAQ up 3.9%.

Of course, today's excitement only brought us back to last week's prices, but we should not be too quick to dismiss the potential power of this move. I think the Federal Reserve has effectively delayed the day of reckoning a while longer, and my 1200 target on the S&P 500 will have to wait another day, another month. The Fed provided just the positive catalyst the market needed just when it seemed none could be found. Bear rallies are typically swift and often violent - you have to respect them!

So for now, we should roll with the bounce. If you must do something, consider lightening up on stocks you have been anxious to dump and hop on trades that benefit from a Fed desperate to provide some kind of floor on the markets and to boost the viability of and confidence in credit. So, we are talking again about the stocks that performed the worst last year and performed the best in January: financials, homebuilders, and that order of priority and upside power. You might want to check out the components of the inverse ETFs that have performed very well the past 4 weeks or so. We should also see commodities continue to move well, but they have already made monster moves in anticipation of a large Fed rate cut on March 18th. It will be interesting to see whether the inflation-related names start pulling back a bit with the Fed futures lowering the odds on rate cutes. Before today the market was at a 98% chance of a 75 basis point cut and is now down to a 62% chance for the 75 basis point cut. The market was essentially anticipating massive action because the credit markets were looking particularly dire. Now, the speculation I am hearing on CNBC and reading on DailyFX is that perhaps the Fed does not need to nor want to cut so deeply. In my previous missive, I was pondering the possibility of the Fed attempting again to tell the market that the rate cut madness would have to end sooner than later because of increasing inflation pressures. Now, the Fed may use this mortgage bail-out scheme as a crutch against the tomatoes and eggs that the rate-cut addicts will throw if the Fed even suggests it is near the end of this cycle.

Lately, I have been very remiss in keeping up with the actual text of Fed speeches and statements. I hope to catch up soon and provide the traditional Dr. Duru spin on Fedspeak...

Until the next time, be careful out there...!

DR. DURU®, 2008