Fed Will Remain Accomodative – Relief Rally. Still Some Issues. Keep Your Powder Dry.

February 22, 2013

Yesterday, the market was fragile, but it was able to shake off the decline from Wednesday. The FOMC minutes spooked investors and Asset Managers pulled their bids. Once the momentum was established, we hit an air pocket.

Last week I warned subscribers that the light volume rally lacked substance. We were in a news vacuum and momentum pushed stocks higher. I mentioned some warning signs Tuesday morning and I thought we would sell off then. These issues came to roost a day later.

Sooner or later the Fed will have to stop quantitative easing. It currently purchases 75% of all debt issued by the U.S. Treasury. That can’t continue forever and this money printing scares me on a longer-term basis. Even when the Fed stops purchasing new debt, they don’t have to immediately unwind their positions. They can maintain a huge balance sheet for a long time and as economic conditions improve, they can sell their inventory.

In yesterday’s comments, I mentioned that Wednesday’s reaction was overblown. A Fed Official (Bullard) said that they will remain accommodative for a long time. The market is rallying this morning on the news.

The sequester is going to happen and those spending cuts will weigh on economic activity. This means the Fed will remain dovish for a long time. Ideally, recent economic growth will offset that impact and we will remain in the sweet spot. Moderate, stable growth with low interest rates is bullish.

China will release its flash PMI Sunday night. The PBOC has been removing liquidity and the government might impose real estate restrictions. China’s retail sales were little soft and all of this news has resulted in a 5% market decline this week. I don’t believe the PBOC would be tightening if economic conditions are fragile. Consequently, I believe the flash PMI number will be decent.

There were other issues this week besides the FOMC minutes and the PBOC. The Philly Fed missed and initial jobless claims jumped. The poor Philly Fed number offsets a better than expected Empire Manufacturing number last week. Initial jobless claims are filled with seasonal adjustments and I am not too worried about this number either. Europe’s flash PMI was extremely weak and that could be a concern.

Wal-Mart posted earnings and they beat. An internal corporate memo was leaked last week and Q1 sales were the topic. The news was not good and the market reacted. Shares sold off and the expectations were low.

Wal-Mart confirmed that retail sales are light. Same-store sales in Q1 will be flat and that will set a negative tone for the entire retail sector. Retailers will be releasing earnings next week and they could weigh on the market.

The results will be a “mixed bag”, but the real concern will be guidance. Payroll tax credits expired and record gasoline prices for the month of February are crimping discretionary spending.

Here is the bottom line. I’ve been saying for the last few weeks that the market needs to bide time at this level. It needs to consolidate gains and it needs a catalyst. Asset Managers want to buy stocks, but they need a reason. The market is near all-time high and they don’t want to chase.

In the next few weeks we will be able to gauge the impact of the sequester and tax hikes. We will also be able to monitor economic activity. If conditions are gradually improving, analysts will raise estimates for Q1 earnings. The bid will strengthen into April earnings season and the market could challenge the all-time highs.

The rally last week was all fluff and that was stripped away this week. There will be reasons to buy and sell over the next two weeks and the action will be choppy. In the end, the market will consolidate within a range. Conditions should continue to improve and it will have enough strength to break out.

Since the opening rally, the market has traded in a tight range. I don’t believe we will see a lot of movement the rest of the day. Asset Managers will wait for China’s flash PMI. I believe the bid will strengthen next week.

Keep your powder dry and wait for evidence. I am finding some nice day trades and I do not have any overnight exposure.
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