Last week, the Fed pulled a surprise move when it lowered interest rates and the discount window rate by .5%. The S&P 500 futures rallied 25 points instantly. It was able to add to those gains on Wednesday and prices are holding firm.
I have been opposed to the Fed lowering interest rates because all of the economic data suggest "full employment" and moderate growth. The exception to this is housing, which only accounts for 5% of our GDP. If the economy continues on a moderate growth path, this ease will translate into a new record high for the market.
Don’t be fooled, on a relative basis the market is not near an all-time high. Once the Fed’s actions were revealed, the dollar got hammered. The market is dollar denominated and a foreign investor buying the SPY would pay much less for those shares now than they did at the prior high two months ago. For anyone who has recently traveled abroad, the decrease in our purchasing power is blatantly obvious. A weak dollar is an inflationary event and it is one reason why dollar denominated commodities like oil and gold are increasing in price. For the first time in 31 years, the US and Canadian dollars are trading at parity.
Enough about the dollar, I’m concerned that the Fed sees the big picture and that economic weakness lies ahead. They have been interviewing top CEOs and gathering unique data to gauge what lies ahead. Chairman Bernanke has been a steadfast inflation fighter and he had to be concerned to take such dramatic action. The market would have been satisfied with a .25% ease combined with help at the discount window. He had the option to wait for further evidence that the economy was slowing, but he didn't.
There aren't any earnings announcements worth mention next week so the market will look to the economic releases for direction. Consumer confidence, durable goods, GDP, personal income, core PCE inflation and Chicago PMI are on deck. Those numbers are like looking in the rear view mirror and they may give the appearance that all is well. Consequently, the market is likely to rally and test of the all-time highs this week.
The only way to trade this market is to stay long commodity stocks and equipment manufacturers that generate more than half of their revenues overseas. There are also select technology stocks that I like. I fear that the market could hit another "air pocket" once the first weak economic number hits.
Editor's Note: To take advantage of our high performance Options Trading Service (HOTS), click here.