Let me start by welcoming many new subscribers this week. I live for set-ups like the week ahead and the opportunities are lining up. I’m glad to have you onboard!
This is the calm before the storm. Last week the market rallied on expectations that the Fed will lower rates. The debt market has priced in a 70% probability of a .25% rate cut and the 30% probability of a .50% rate cut. The dismal Unemployment Report dramatically increased rate cut forecasts.
The U.S. dollar hit new 30-year lows against the Canadian dollar and against the Euro this week. We have a huge trade imbalance and a weak dollar forces us to pay more for the goods we import. Translation: a weak dollar is inflationary. Oil has just hit an all-time high. Last week, TSN said that profit margins are being hurt by higher food costs. I've even heard that Italians are boycotting pasta because wheat prices have forced it up 25%. There are countless examples of inflation (tuition, health care, local taxes) that don’t show up in the Fed’s numbers. Tuesday, a “hot” PPI number could add to the excitement.
I believe the Fed will reluctantly lower interest rates by .25% next week. They will lace their rhetoric with inflationary comments to curb future rate cut expectations. The market will have an initial negative reaction.
The earnings releases by LEH, GS and BSC will be much more important. To a degree, the Fed’s actions are priced in. However, no one really knows the earnings impact from the sub-prime/credit crunch debacle. Historically, LEH has made a 2% move after releasing its earnings. The option implied volatilities are pricing in an 8% move in either direction. Lehman releases before the open Tuesday while Goldman Sachs and Bear Stearns will be releasing earnings Thursday, after the Fed's decision. FDX also announces this week and transportation activity measures economic strength. GIS and CAG will shed light on food costs.
Earnings and the Fed’s actions/statements will determine the market's direction for the next month. Quadruple witching will throw gasoline on the fire, accelerating the move. All you can do in these situations is to have your stocks lined up. We will trade relative strength and weakness in a balanced manner.