Head And Shoulders Above
One day before the Fed makes its next adjustment to monetary
policy, major stock averages are lining up ominously at the neckline of head-and-shoulders top patterns. With volatility compressing, a larger-than-normal move
is likely in the aftermath of tomorrow’s interest rate decision and announcement
at around 11:10 PM ET.
In a twist characteristic of Wall Street’s collective
thinking, stocks are falling after economic reports show the economy may be
healthier than many observers had believed. Durable goods, new home sales, and
consumer confidence all came in stronger than expected. The reports suggest the
economy is healthier than believed and that cuts the chance of the Fed lowering
interest rates by a more aggressive 50 basis points, delaying a revival in
corporate profitability.
The most accurate predictor of likely Fed rate action,
the nearby Federal Funds futures contract (FFN1), priced in a reduced
chance of a half-point cut after the full slate of economic news was released
this morning, reducing the odds from 56% to 40% for the 50-bp move.
“Just” a 25-basis-point cut could be the
catalyst that promotes a breakdown below the neckline in the major indexes, as
the market more fully realizes that corporations may not return to profitability
anytime soon and that the Fed is quickly approaching the maximum it can ease
rates. As Tony Crescenzi pointed out on Live On TradersWire’s new interactive
feature this morning, “the Fed does not like to lower rates below the
inflation level because that feeds inflation.”
With the Fed limited in its capacity to further cut
rates, other forces will have to come to the rescue of an economy that certain
reports have shown is in a manufacturing recession.
Merrill Lynch
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today when the brokerage said it would miss profit estimates by as much as 37%.
Merrill’s 11% drop is bleeding over to other financials: the largest stock on
the Dow, American Express
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Goldman Sachs is doing its bit to lower expectations in
tech by cutting profit estimates for such brand names as IBM
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Microsoft
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Traditional measured-move analysis calculates that a
market will move twice the distance from the head to the neckline out of a head-and-shoulders pattern. This implies that the Nasdaq Composite will move to test
the April 11 gap.