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Factors Favoring a Flatfooted Fed

June 16, 2000

The best recent sectors . . . were the worst performers Wednesday; largely due to telecom as well as semiconductor pressures; the former on downgrades (and some fundamental concerns), and the latter simply acceptable profit-taking, after their recent extraordinary targeted run-up.

More and more, economic numbers as expected are supporting our ideas that economic activity would cool a bit, if not contract more seriously. The CPI was benign, and as we've argued before this month started, we think the Fed is either done or about done: ideally freezing in their tracks right now, and fearful that the higher Oil prices have already amounted to the equivalent of a tax hike for Americans; hence making it overkill for the Federal Reserve to press our citizens further.

How this impacts the stock market can be very interesting; especially after it paused right here in the middle of a Triple Witching Expiration week, despite a 67 point gain by Dow Industrials. There are several factors likely at work here: a) profit-taking after huge runs in many stocks, not the least of which are a number of our long-held investments, while small NASDAQ stocks are commonly boring this time of year (though that doesn't mean uninteresting for patient investors); b) the speculation on our part that previous upside earlier this month probably consumed some of the potential upside unwinding fuel for this particular Expiration, which could mute the action; c) the technical proximity of a "head & shoulders" top, which provided resistance as also thought, although we think we know what might happen if and when the market works through that; and d) the market's overbought daily basis condition, which can be worked-off by generally sideways-to-lower (or ideally slightly higher) action, preparing for a potential explosion upward, which might coincide with the Fed not moving, then (reserved), per the overall gameplan. In the interim now, symmetrical pattern resolutions may be again taken to the upside overall before new risk returns.

Of course this isn't always easy, as this time of year new monies are reticent about coming into the market; Oil prices have the specter of inflation truly worrisome (as thoroughly outlined just in the other evening's comment) to many; and many investors who failed to heed our February and March frequent warnings (even while calling that rally) that the move was "unsustainable at what was a parabolic angle of upside attack", were probably severely damaged in the forecast April & May declines, on a rotational basis. That of course formed what we projected and assessed as a "complex bottom" of this year; meaning that the "grand dames" in the Nasdaq 100 (NDX) weren't expected to trough-out until May, but that was expected to be the low point for the cycle, with this month's selling essentially a secondary test of those lows. (There are some worrisome aspects.)

(Technical analysis reserved.) Contrary to those who turned negative into weakness, an upside ramping was as you know the call here, and now to some extent you're dealing with the bears last chance to stop the move. That's probably why some invalid (by our assessment of economic indicators trying to masquerade as stock market indicators) elderly theories about the market were trotted-out in the past week, and why some who were the casualties of our forecast April collapse are appearing in the media, most certainly to discourage Americans about the future.

If we were cynical we'd say so they can talk the market down in order to pick up bargains missed while they were selling in a panic at the time, whether compelled to liquidate or by choice, maybe varying with such money managers approaches, or involvement with derivatives (a greater risk). And then of course there's the absence of venture capital money, which makes it just a bit harder for some of the money managers to attract private capital, as they're now competing with private equity venture pools in ways unfamiliar to many of them. On the plus side of this, such a dearth of capital is slightly offset by the market's purge (reestablishing value in many sectors over the indicated rotational timeframe), and having no hot IPO market existing now, which isn't drawing funds away from stocks, that might otherwise go into normal equities or other investments.

(Commentary conclusions reserved.) Put it all together; and it's a backdrop for fairly muted action on a day like this; which remains definitely rangebound, as everyone debates whether all of this means the market's glass is half empty or half full. The tech rally is behind, retail was clear and pure risk, as outlined for months (especially e-tailing), while we see the action is perfectly in a normal give-and-take mode, even though we expect to see more upside into a Triple Witching.

Perspective

This hasn't been an easy market for investors or traders all year, contrary to many perceptions in the 1st Quarter, by those who sometimes saw a parabolic market as good, not as increasing the risk we then described. We saw that upside as a harbinger of illiquidity, just as we interpreted the ensuing collapse as an intended rebuilder of liquidity, although many probably will still disagree, or didn't understand what we meant. The primary purge was expected to come from the wild and parabolic move-up earlier this year which was predicted to be totally unsustainable, concentrated in the narrowly-based leadership, and an assortment of more or less speculative stocks (the less speculative being certain under-exploited optical or other areas that really can be beneficiaries of growth in the early part of this decade, and the latter more speculative biotechs, and others that were lifted by the incredible mania of that moment as well as frantic short-covering), and all that was accompanied by fleeting -but notable- air pockets which identified a clear absence of buyers whenever the market started to stumble, as well as retrenchments of orderly market-making by many major firms, which we'd forewarned were cutting back participation or leaving the business.

During that excitement, we emphasized how the characteristics were as close as any seen in our lifetime to that prevailing before the 1929 crash, because of the implied illiquidity, a concentration of capital (particularly in the so-called "dot.coms"), and the dearth of money to other investments; a sure sign of trouble brewing. Further, we focused on the hedge funds, where leverage exceeds by far the normal perception of margin in this Country (and fixed blame for what might come, not only to the funds, but to certain banks here and abroad, which aided and acquiesced in all this).

What's the point now (though we're proud of warning of the whole situation)? That we also came to the conclusion that the outcome in the wake of devastation didn't have to be the same as in all the historic disasters (after the Civil War, the Russo-Japanese War, World War I), and of course 1929, and the minor debacles we publicly nailed in 1969-'70, 1973, 1987 and not forgotten 1990, all events that didn't seem minor (and weren't) at the time, but appear so to new investors, when they gaze (typically) at logarithmic charts, which make purges look as if they were mere blips.

Looking for flatfoots

Will this year's drop become a mere blip in history? Sure; though it was expected to clean-out the excesses and remove certain phenomenons (such as overly zealous hedgers) from the scene. In a large way, this has occurred, with financial wealth-effect damage, sufficient to dissuade what became an overly-zealous Fed (in the wake of their own excess money supply pre-Y2k stimulus) both late last year and earlier this year, as frequently outlined here (both before and afterwards).

If we're right about the Fed, who had their foot on the gas too long, and then the brakes too hard; well, that's an argument not to compel the equity Senior Averages to join the broad-based list, in a trauma that will take months (if not longer) of basing and consolidation to fully restore. With the approach of National Elections, we've felt for nearly a year that the worst would be seen in the 1st half of 2000, with increasingly (because of damage and slowing already wrought, some of which is actually structurally healthy in restoring sane lending and analytical policies if not pursued too far) an easier reign on the monetary aggregates in the year's second half. The annual forecast in fact outlined the necessity to contract the Fed's money supply excesses, that were building well ahead of Y2k, and to do so in the first half, even if painful, so that the Fed wouldn't likely have to be engaged in restrictive monetary policies later this year, right into a National Election.

Hence, there is hardly any change (at least thus far, subject to revision) in the entire forecast of a very incredible year; and that includes the expectations for the Fed to get at least flatfeet for now, and then we'll see how things go as discussed the other night down the road and next year. If we get a neutrality stance (and no move) from the Fed, we'll have the arguments about which shall mean more; the earnings pressures or the ease of rate pressure; and the answer is several fold, as already outlined, and also detached. On earnings, we argued before the year started that too many forecasts were absurdly optimistic for the year's first half; on rates that will first reflect what we said it would, a slowing and profits pressures (with stagflation risks, outlined months ago as we all were subjected to droning nonsense about new eras, and no inflation ever, and DJ 36000) for a couple quarters in many areas, but then robust improvements if we can sidestep recession. The detached factor was the impact of Oil (balance reserved for subscribers).

Technicals; Daily action; Bits & Bytes Economic News; (reserved sections for subscribers).

Anyway, S&P guidelines (on the 900.933.GENE hotline) caught some early gains, but not much in the afternoon (because we tried to smooth the longs with fixed mental stop points), actually gave back about 300 points, and then made it up immediately on the long side in the late rally. Thursday's pattern is difficult given all this Wednesday churning, but we suspect it may open higher, sell-off and then recover, as S&P's continues to fight very hard for a close above 1500.

In summary . . . the Beige Book saw some concerns about rising prices, and certainly some economists think the Fed will hike rates just because of high Oil. We disagree, believing that the Fed is sophisticated enough to know that rates won't move Oil (in and of itself), but that high Oil and high rates are anathema to the soft-landing everyone should desire. McClellan Oscillator readings are currently around +96, actually improving a bit (interpretation reserved).

Flat S&P daily action for the moment; with September futures near 1498 ahead of Thursday. As of 6:50 p.m. S&P on Globex carries a 2716 premium, with futures unchanged from the regular Chicago close. We're looking for even firmer overall action on Thursday, ideally after minor new efforts to sell-off after a possible upside opening. The market's somewhat overbought short-term.


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