Fed Fixation

You would be forgiven for wondering if you’d fallen into a deep sleep after last week’s article, only to wake up months later to find this one.

“Surely,” you think, “things couldn’t have changed this much in just a week.” But they did, or at least people thought they did and reacted appropriately.

Last week, the Dow hit a six-year high and was within 150 points of its all-time closing high of 11,723 booked in Jan. 2000. People crowed about strong earnings and a weak employment report that was bound to make the Fed pause its rate-raising campaign after Wednesday’s 0.25% hike. That’s why everybody watched the Fed’s statement closely on Wednesday; they wanted signs of a pause.

Then on Wednesday, we got the rate hike as expected, but we didn’t get the signs of a pause. The rate went up 25 basis points to 5.00%. The statement read “some further policy firming may yet be needed to address inflation risks” and that “the extent and timing of any such firming will depend importantly on the evolution of the economic outlook.”

That should sound familiar. It’s roughly what the Fed has said at other recent meetings. It’s waiting on the data. If economic growth keeps trucking along and signs of inflation appear, then we’ll get more rate increases. If economic growth tapers and there’s no evidence of inflation, then Wednesday’s rate boost could be the last one for a while.

A glance back at this year’s earlier articles will show that this wait-and-see stance has been the Fed’s official word all year.

But the market seized on the lack of a definite statement ending rate hikes and it was enough to start the dominoes of negativity falling. Last week’s happy talk of strong earnings and weak employment went out the window. In through a termite-chewed hole in the floor came talk of an impending interest-rate induced earnings slowdown (which we’ve seen coming all year) and a fatiguing consumer (old news).

There was the usual disagreement about what constitutes good and bad data. For instance, before the bell on Friday we received news that the March U.S. Trade Deficit narrowed for the second month in a row to $62 billion. Economists expected it to be around $67 billion. A lower trade deficit is great news, but, wait…no, it’s not. It means we have to revise first quarter gross domestic product growth upward, and that could be a sign of inflation.

Right about the time that thought entered the collective conscience, somebody quipped that the price of imported goods bounced higher than it has since September. That smelled like inflation, too.

Then, the University of Michigan consumer-sentiment fell to 79 in May from 87 in April. We have to go all the way back to October’s score of 74 to find a lower reading. That could have been taken as a good sign that inflation is not a threat because people are not buying much. Instead, it was taken as a thumbs-down for economic health.

Oh, and commodities are still skyrocketing. On Thursday, gold closed at a 26-year high, silver at a 25-year high, copper rose 9% in the morning and closed at a historic high, and oil gained 1.6% to $73.25 per barrel.

No two ways about it: last week’s party is over.

Thursday was the worst market day for the big indexes since Jan. 20. The Dow ended the week down 0.5%. The S&P; 500 lost 1.6%. The Nasdaq dropped 3.4%.

The main negative factor was interest rates. A bevy of analysts came out with either predictions of more increases ahead, or doubts about their previous convictions that we’ll soon see an end to the increases. Here’s a representative example. Speaking about his firm’s position that the Fed will be able to hold at 5%, Deutsche Bank’s top U.S. bond economist Joseph LaVorgna said that “given the FOMC’s increased sensitivity to inflation risks, we admit to feeling less comfortable with that position.”

The week’s action was negative enough to make some subscribers wonder if the August/September market plunge I’ve warned about is already underway. Is it time to bail out? Should we be taking a position in a short fund immediately?

The answer to such critical questions is reserved for subscribers.

The good news is that you can become one for just a penny. That’s right, I offer a full month of The Kelly Letter for just a penny. I’ll send you the answer to the above bail-out question; weekend updates on Asset Acceptance Capital, Dell, Disney, and Microsoft; give you instant access to my report on the recovery of Japan; and provide you with a user name and password to access all archived Kelly Letter notes from the beginning of this year.

One other thing. Many times in the investment business, people join an advisory service when everything is going well and the positions in the portfolio are pushing all-time highs. That makes for a lot of excitement, but is actually bad for your returns. It’s better to enter when prices are down and you can buy into positions at a price lower than the service paid.

Guess what? Now is a great time to join The Kelly Letter. While it’s true that we just had a position hit a 100% gain last Wednesday and that several others are up substantially, we also have some key positions currently in the red. Over the summer, we’ll be averaging down into those positions to lower our average buy price in anticipation of a strong fall/winter rally.

Why not come aboard for a penny and see what I’ve got planned? It’s well worth your while just to review the portfolio and research notes, but I think you’ll also discover that market-beating investment information can be a pleasure to read and affordable, too. Did you know that 86% of all Kelly Letter subscribers have stayed with the service? That’s an industry-leading figure. Find out what makes me different, and how you can make money by taking advantage of the upcoming summer slump ahead of the powerful fall/winter rally.

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