Sunday, May 28, 2006

Weekly Recap

The previous weekly wrap concluded with "the fundamentals haven't tanked as much as the market." This, week, the market came to realize that, and found its footing.

The week opened with a continuation of the poor sentiment from prior weeks. The S&P opened sharply lower on Monday morning and even though it came off its worst levels, still closed with a loss of 5 points. There was no specific news to account for the decline. Anything remotely bearish could be ascribed as a factor, but it really was just poor sentiment. Underlying that was concern that the Fed would go too far in raising rates and that economic growth would slow significantly.

This thought process included some ridiculous talk that a decline in commodity prices was bearish for stocks because it reflected weak global demand. But the daily fluctuations in commodity prices are driven much more by speculative positions than daily changes in underlying demand from China.

The market was extremely volatile on Tuesday. The S&P was up more than 10 points in the morning but gave way to a late sell-off to end down another 5 points. There was again no real news that moved the market. Sentiment was the overriding factor, and that sentiment was mostly about fear. That even included highly suspect worries about the impact of avian flu.
Wednesday was another very volatile day with one exception - the S&P closed with a 2 point gain. A more positive tone was supported by a surprising increase in April new home sales. This helped ease fears about the economic outlook.

Thursday the market rocketed higher. The S&P gained 14 points. Press reports ascribed it in part to an upward revision to first quarter real GDP to 5.3% from an originally reported 4.8% and an unchanged price deflator. Again, however, it was not so much the actual data as that fears were being squeezed out of the market on numbers that were largely in line with expectations.

That was the case on Friday as well. The April core personal consumption deflator (PCE) was up 0.2%. That was in line with expectations. It pushed the year-over-year increase in this closely watched inflation measure to 2.1%, up from 2.0% in March. That is above the Fed's forecasted range of 1 3/4% to 2% for all of 2006. There was nothing particularly bullish about the data. It also later became widely known that the increase was actually 0.249%. A slight fluctuation in one component and it would have been a 0.3% gain.

No matter. The market was comforted by the as-expected 0.2%, and the S&P gained another 6 points on Friday.

For the week, the fundamentals were little changed. The economic data was mixed. April durable goods orders on Wednesday were weaker than expected while new home sales were stronger than expected. Thursday brought the GDP data noted above and an as-expected dip in existing home sales. The core PCE deflator data was released on Friday.

There were very few earnings reports, and none of broad impact. The yield on the 10-year note dipped to 5.05% from 5.12%. Oil rose to $71 a barrel from $69 a barrel. And, despite all the talk about implications for Fed policy of every bit of news, fed funds rate futures barely moved. They still incorporate expectations of one more quarter-point rate hike this year. All in all, the news was mixed at best.

Yet, the market tone went from decidedly bearish at the start of the week to neutral or even a bit upbeat by the end of the week. This was due to the fact that the worst fears were taken out of the market. The economy isn't about to hit a wall, and earnings growth will be at least decent through year-end. Inflation may be firming a bit, but not tremendously. The Fed may have to raise rates again, but probably just one more time.

The fear that the Fed may go too far, drive the economy into the ground, and completely ruin the stock market outlook, has eased considerably.



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