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Perenial Keys: Liquidity and Time

June 30, 2001

Fed reticence . . . was actually our preferred strategy for this FOMC meeting, as you know. We thought 'bet the ranch' approaches to draconian cuts (after so many which have yet to work their way through the system) were irresponsible calls on the Fed to depart what others think is a Chinese-water-torture approach to stimulus, but isn't. In a number of missives, we've outlined what amounts to the overnight repurchase rate equaling (if they cut further) the inflation rate, and that's anathema to policy makers.

So they may cut further; but when it's closer to having much more-immediate results. In our view, with late Summer expected to be a soft economic environment anyway (and with the Nation for all practical purposes in a recession for sometime, outside of a few sectors), there was, as noted last night before the Fed's announcement, some risk that a draconian Fed cut some advocated would have no impact this time of year, and that would instill a greater fear in investors (and businessmen) than not doing an outsized-cut, or doing a 25 basis point trim, which has been our bias for some weeks.

We suspected if the Fed followed the view we embraced, it would be the right thing to do, but wouldn't get the immediately favorable market response, and it didn't; though we did get the subsequent bounce-back also thought probable in such an outcome. It goes without saying that while today's rate cut doesn't directly stimulate what can't (in our view) be stimulated this time of year, it does leave ammunition ample; and that's what the Dow Jones Industrial Average said by its relatively benign response to the supposed disappointment.

Many analysts also argue that the lack of increasingly rapid declines in rates, at this point, postpones the recovery prospects for beleaguered technology stocks. Just the opposite, say we. In fact, we made that argument last year and early this year, with a belief that the kind of misery technology companies have gone through would for the most part become 'ingrained' until we got through the Summer, and into a new series of products, for which many IT managers would be waiting, even if capital spending budgets were less constrained. That's part of the reason why we believed rate cuts in excess of what the Fed did, wouldn't have helped the techs in particular; though we would note the NASDAQ breadth was mildly positive, the Composite up, and so was the basing (in our view) Nasdaq 100 (NDX), which includes several stocks expected to benefit particularly by these product transitions anticipated late this year and next.

Wireless is notable by its relative absence; partially for the same 3G delays that have hampered the sector's appeal well before the start of this year, and into next. At the same time, inclusion of AT&T Wireless (AWE) in the S&P soon, will help focus some attention on the sector once it bottoms-out. (For holders of AT&T (T) itself, selected in the teens by the Letter, the approximate 1-for-3 distribution to 'T' holders, of AWE stock, is effective to holders-of-record in AT&T by June 22; to be distributed July 9.)

Back-to-the-future… our Fed interpretation, as it turned-out, probably mirrored the dominant view over at the Federal Reserve, though we certainly had no intimations from them about how they'd act; nobody ever would. We just thought it was logical, and that they should resist the growing chorus of self-interested cries for additional stimulus from certain economists that generally extol ideas we agree with, but not with respect to this particular FOMC gathering. Frankly, by limiting today's cut to a quarter-point (and the Discount Rate as well, which is equally important), the Fed lets the existing lower rate structure already in the system work-through-it, and then can cut further as we get closer to seasonally more appropriate times to expect that sharp cuts might have a favorable impact; though decisions should not be rigid from here.

As a matter of fact, we suspected that a draconian cut (so argued for by the Street), if it occurred, would actually endanger the nuances of downside exhaustion, by telling consumers and investors that things are so bad they need such stimulus. They are in fact bad; but those big cuts (in our opinion) wouldn't have helped anyway, so why do them? The Fed agreed, and the only thing we would quibble with was their statement regarding no visibility of a return to profitability, which while correct, could have noted some signs of downside exhaustion, such as the housing industry has displayed. But we think we know why they withheld such remarks; which would seem inappropriate if the Fed moves to cut further down-the-road a bit. Another reason would be a sort of delicate balance that helps keep the Dollar firm, ahead of a seasonally dubious time.

The importance of all this is incredible, as the prospects for an American recovery are daunting enough, while foreign stability becomes an impossibility in some areas, if it's not possible to revitalize growth in the U.S. Substantial weakening in Germany has its roots in a failure to ease their own monetary policy, while Japan is embroiled in what is their most radical restructuring since the entire postwar reorganizations, that didn't retire all of the relationships between banks, government and business, to the degree an enthusiastic U.S. led democratization process promised, and still believes was so completely accomplished. While great things were achieved, structural rigidity really exceeded (to this day) that of the West, and only now is being broadly addressed. By no means are the results (or the rapidity of recovery) ensured; another reason a firm U.S. stock market, and strong consumer demand, are so important as a backdrop.

From our standpoint, the Fed is conserving their dwindling fodder to fire when targets are more visible (we'll get to that in the technical section briefly), and that should help particularly if it's combined with a statement about 'ensuring' signs of exhaustion and recovery, that may well be present by the ideal time such further efforts are injected. In the interim, T-Bondsreacted very well to the nominal cut, and the statement. With long-rates dropping about half-a-point (balance reserved for readers).

We emphasized time and liquidity injections (monetary growth) repeatedly of late; in last night's DB as well, and it's important to monitor that, to recognize any signs that might depart from the eventually optimistic view. So, if this expansion doesn't halt, and the Dollar isn't hard-hit during a late-Summer swoon, the U.S. should again be in decent position to rebound; which is why 'fighting the Fed' remains highly risky. This may be doubly-true with respect to betting against the Chairman's intrinsic opinion by virtue of the mild move, that we are working on the last legs of the downward cycles.

And that, most evidently, is why the markets didn't implode with just a minor rate cut, as they are definitely focused on the Fed's view, which they perceive as important. It is correct that this Fed Chairman has made mistakes in the past, but mostly relating to being late with the directional shifts. From that perspective, his decision is notably conservative, so tends to signal that ingrained Street pessimism doesn't comprehend the built-in economic stimulation by the cuts that have already transpired. Since these typically take 6-9 months to take-hold, his bet is that this Fall will see the seeds of the recovery, and generally that's has been our view too, for some months. As for ideas of trying to bottom-pick the Senior Averages; well, that's likely been accomplished for us, during the Winter, as postulated. At worst a late-Summer swoon would test that. (We called for the move to temporarily top-out during June's early 'fling', then drop so as to get everyone negative again, and questioning the thesis; then rally anew; now.)

What we're hoping, is that after a speculative minor rally into July, we rollover into the (reserved condition/levels), but maybe just the relatively high-end of that (stay-tuned), and then as it unfolds (the swoon) amidst renewed gloom, that it will not be overcome by optimism on markets, psychologically contributing to the secondary capitulation's actual end. Without bells being rung, recoveries will start, rotationally. In the interim, real estate prices will not crash (because citizens finally recognize the value of those tax changes enacted five years ago, intended to compel diversification of assets into near-historical norms, as we argued they should amidst market hysteria then). That will absolutely be helpful to the sustainability of the U.S. economy until softer area rejuvenation kicks-in. We clearly see why the Fed didn't cut further in this meeting. At the same time, lower demand from the weak economy contributes to a long-forecast swoon in Oil prices, that is finally being reflected in rising gasoline inventory and the declining prices, that we strongly felt would occur during the course of the Summer's driving season, not later; which probably made us among the few calling for the drop.

Because the Fed statement addressed 'risks in the foreseeable future', we interpret that as already telegraphing the next move by the Fed. The drop in foreign currency markets concurrently, and renewed nominal gains of theDollar, support all of this. At the same time, overseas uncertainties would tend to sustain Dollar strength anyway. The decline in Oil prices will be helpful in Europe too, where interest rates haven't yet been cut as much as they should, and on both sides of the Atlantic, are equivalent to a significant tax cut; more so than the nominal rebates that are so overly-embraced.

Daily action . . . is also reserved for subscribers; though notes the pleasure of being on the long side for the majority of recent days' action, after forecasting a mid-month low point. The (900.933.GENE) hotline is satisfied with these results for the two days of FOMC, and looks forward to the pattern outline Thursday, which probably won't be decisive, but could be tradable, as postulated. Next week is broken-up with the 4th of July right in the middle of the sessions, which interrupts the sometimes-normal flow of events. We also will have to remain on alert for any attempted terrorist interruptions during a most-American Holiday, which comes too close to the recent warnings for comfort. So, while comebacks will be erratic (and likely transitory), then can occur.

In summary . . . virtually every number and sentiment (reported or otherwise) until very recently, has tended to affirm semi-recessionary conditions or worse. This hasn't changed vastly; though slight improvements in sectors of some economic reports are very welcome, as noted the other day, including the higher numbers in housing, as discussed earlier, and the confidence numbers, which are sometimes questionable.

If we had to worry about what (fundamentally) will worry investors later this Summer, it might be failure (which is normal) of a late-season economic comeback, currencies, and also the worry about write-offs, as some companies try to mark-down their losses not only in inventory, but in valuation due to debt service and declining prospects, as some accounting firms require since the FASB rules changes. How important this will turnout to be is debatable, due to the possibility that such write-downs may not occur until we're at a point of inflection, where the economic recovery is increasingly visible.

McClellan Oscillator data improved only guardedly. Wednesday's -30 NYSE read, and NASDAQ's -9, are in harmony with the events of ongoing consolidation; actually with a slight upward bias again. Continuing to suspect renewed late June rallying overall, after the FOMC meeting, and worrying less as to whether it's sustainable into Quarter's end, and more concerned that it snapback in early July; though our overall forecast still expects more rocky times (reserved as to when). We did not assume the S&P move that instantly occurs as reaction to the Fed's decision, is where things will be at day's-end. By the time things sort-out, the market's fairly neutral; that's positive.

The proximity to rollover into a new Quarter now has to be factored-into our thinking. As of around 8:00 ET Wednesday, S&P premium is around 1000 or so; futures near 1221; up 2. anticipates procedurally higher price levels, for now.

The first use of gold as money occurred around 700 B.C., when Lydian merchants (western Turkey) produced the first coins
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