What Is The Fed Likely To Do Next?
Late Phase
Market
The Fed’s rhetoric has inched
toward more dovish in his Humphrey Hawkins speech, leading us to expect that the
pace of tightening will slow sometime this summer as short-rates approach what
the Fed has described as the “neutral zone†between 3% and 5%, and yet the
February FOMC minutes would make one think the Fed is set on raising rates for
quite some time. Clearly the Fed is convinced that the economy is in a
self-reinforcing expansion that will require tightening to slight pain to slow
before inflation problems develop. Some Fed members are concerned about
inflation risks, but it seems clear that the Fed will tighten to 3% and then
weigh the evidence and continue to tighten slowly until evidence of slowing
appears. However inflation is unlikely to become a serious enough problem to
warrant a full-blown recession in a world awash in goods from Asia. It is also
unlikely that Greenspan will err on the side of painful over-tightening in his
last year as Fed Chairman. A mid-expansion pause or soft-landing (similar to
’84 and ’94) is thus likely to develop from this cautious but determined Fed
approach — not a full scale monetary squeeze and resultant recession. Such a
scenario likely will be painful (though not disastrous) for many asset markets
(US equities in particular) and will eventually slow the economy (a growth scare
would develop), but will not lead to a full-scale recession absent exogenous
shocks. Yet risks of a market setback will rise until the Fed backs off on
tightening. And ultimately when the Fed does back off, the seeds will be sown
for another rally leg in bonds and stocks — and it is this rally later in the
decade that may become more speculative and mania-like.Â
In US and global equity
markets, value/growth appears to be working and logical whether the market moves
up in a late phase rally, makes a volatile top over months to years, or even
moves down as the softness takes hold later on. Select European and EM’s over
the US seem likely to continue unless a true global recession takes hold as
well. Energy outright seems a good speculation to treat gingerly, while energy
over the market and over soft sectors seems more reliable with much of the
upside intact. More neutral long/short strategies that buy the strongest
sectors like energy, managed care, soft drinks, foods, staples, rails, base
metals and short weaker sectors like financials, brewers, US autos, airlines,
and parts of the technology sector — also seems a good profit generator, albeit
with some volatility, in this new era. Selected EM’s outright and against the
US seem good speculations with caution, such as Korea, central Europe,
Indonesia, South Africa, Chile, and China. Investors should adopt a much more
equity defensive and negative market stance if US bonds breakdown through the
lows since last August (above 4.5% for 10-year Treasury) — or if oil prices move
sharply to new highs without corresponding new lows in bond yields to cushion
the blow from oil.Â
The market has now retested its
highs in some indexes and then backed off some. A handful of global markets
continue to march on to new highs (many Europeans, some Latin and Asian EM’s).Â
Traders should be more cautious than usual in what appears to be a late phase up
in the final leg of the bull move since 2002.
^next^
Our model portfolio followed in TradingMarkets.com with specific entry/exit/ops
levels from 1999 through May of 2003 was up 41% in 1999, 82% in 2000, 16.5% in
2001, 7.58% in 2002, and we stopped specific recommendations up around 5% in May
2003 (strict following of our US only methodologies should have had portfolios
up 17% for the year 2003) — all on worst drawdown of under 7%.  This did not
include our foreign stock recommendations that had spectacular performance in
2003.Â
This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 105, 76, 90, and 37 with 18 breakouts of 4+ week ranges, no
valid trades and no close calls. This week, our bottom RS/EPS New Lows recorded
readings of 9, 10, 16, and 9 with 12 breakdowns of a 4+ week ranges, no valid
trades and no close calls. Valid signals remain in place in MLI, BHP, USAP,
LCAV, and JBLU.   The balance of longs and shorts and breadth in top RS NH’s
versus bottom RS NL’s is slightly positive but drifting lower this week.
For those not familiar with our long/short strategies, we suggest you review my
book
The Hedge Fund Edge, my course “The
Science of Trading,”
my video seminar, where I discuss many
new techniques, and my latest educational product, the
interactive training  module.
Basically, we have rigorous criteria for potential long stocks that we call
“up-fuel,” as well as rigorous criteria for potential short stocks that we call
“down-fuel.” Each day we review the list of new highs on our “Top RS and EPS New
High List” published on TradingMarkets.com for breakouts of four-week or longer
flags, or of valid cup-and-handles of more than four weeks. Buy trades are taken
only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts
are similarly taken only in stocks meeting our down-fuel criteria that have
valid breakdowns of four-plus-week flags or cup and handles on the downside. In
the U.S. market, continue to only buy or short stocks in leading or lagging
industries according to our group and sub-group new high and low lists. We
continue to buy new long signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors stop at 50%
long and 50% short). In early March of 2000, we took half-profits on nearly all
positions and lightened up considerably as a sea of change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since, and did not get to a fully allocated long exposure even
during the 2003 rally.
Mark Boucher