On the other hand last night the Fed raised one of the two interest rates it controls. This is the rate that the central bank charges for emergency loans to banks. It went from .50% to .75%. This is a sign that the Fed sees enough improvement in the financial sector to start tightening money though this is one of the most benign tightenings it could undertake.

Inflation and the Fed’s action is good news both for the economy and the stock market. Inflation is not a problem yet and the Fed has signaled a willingness to fight future inflation by making a move, albeit a minor one, early. It is also a sign that the dollar may not be as weak as feared. Of course this is only one small first step. Still the battered dollar is faced with a massive spending program which will continue to push its value down.

All and all this was a good week for the stock market and the economy. Only time will tell us if the correction is over.

Good Trading
Steve Peasley

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By mid week, after a couple good days, we had a sell off on Thursday which was broad based and painful. However, this morning with the bank stress test and an employment report for April behind us without any surprises the market decided to rally again, at least so far this morning. This is an obvious case of the market climbing a wall of worry.

The economic numbers actually were very encouraging this week. Retail sales were up for April by .3% and for last week up .7%, but what was more surprising was the first time jobless claims which fell by 34,000 this week and the four week average fell as well by 14,759. True jobless claims sit at over 600,000 which are very high but the stock market cares about the trend and is looking for the beginning of the change. That seems to be happening. Can this change turn into actual growth? At some point it will but not for a number of months, maybe by the fourth quarter this year or next. At some point the worry will turn to the strength of the recovery but so far no one is talking about that, yet!

We have had several weeks in which economic numbers, though still showing us that the U.S. economy is in a recession, seem to point to a turn from free falling to just falling or leveling off. The just ended earnings season came in better than expectations. Of course those expectations were severely downgraded at the beginning of the year therefore beating them is not all that difficult. The real test will be the sustainability of improving numbers. Can that happen?

I believe it will. The LIBOR rate is now below 1% when a few months ago it was as high at 5%. That is the rate banks lend to each other. The mortgage rates are at 5% or less and this week we saw productivity increase by .8%. Add these stats to all the others these last few weeks and we have strong evidence that things will get better. Finally, China, who embarked on their own stimulus plan, is already showing signs of strengthening growth despite the slow down in exports. The guidance, by independent firms, is calling for an increase in China’s GDP from 6% growth to 8% this year.

Does this mean the stock market is going to rally straight up from the March 9th low? Probably not. We will have corrections along the way. Any correction will be one to buy not sell. At the same time taking profits every so often is not a bad thing. Since China is already recovering and growing we have increased our exposure to the Asian market. You need to go where the growth is and since the stock markets of the Far East fell a lot harder than ours it has made all of Asia a good place to invest, despite the risks of lack of transparency and multiple books that their companies keep.

It is time to invest and has been for several weeks. No one knows when and where the bottom is but we can look back and clearly see a strong bottom of the various markets that took place on March 9th. Put fear aside and let’s make some money.

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The market struggled this week but was resilient. In the first part of the week fear about the ‘stress test’ hovered over the traders. The unknown result will not be known to the public until next week or the week after. On Tuesday there were hints that Bank of America and Citicorp were being pressured to increase their capital structure though the CEOs didn’t agree. That pressure was a direct result of the stress test- at least that is the assumption.

Consumer confidence increased sharply in April. The Conference Board’s reading went from 26.9 to 39.2. That reading is still low but the degree of increase was unexpected. Later in the week a Consumer Sentiment report was released and it too was higher. I would not read too much into these numbers. You can look at actual retail sales each week which will give you more information than a monthly confidence report. Much of the confidence (or lack of confidence) by consumers may mean very little to us as investors. The swine flu for instance may affect consumer confidence but will that mean consumers will stop spending? They might spend differently. Any recent event will affect how people ‘feel’ about things, good or bad, but will it actually spur them to spend or stop spending? The evidence is unclear.

Also out this week was the Case-Shiller 20 city home index report. The problem with this report is it was for February. That is ancient history to the stock market. It showed a fall of 2.2% adding to January’s fall of 2.8%. Prices year over year were down 18.6% from 19% in January. This report is virtually useless. It tells us what happened two months ago. Who cares! I will not be writing about this report in the future. We know from more recent data that sales in homes are increasing and inventory looks to be flattening. It’s still too early to come to any conclusion. Housing will be weak but evidence suggests a bottom is on the horizon.

Also out this week was the first quarter GDP number which was down 6.1%, a bigger drop than expected. The market rallied strongly when this number came out. Welcome to the psychology of the stock market. So why would it move up? First, this number is also backward looking, but looking closer you will see that there was a large drop in inventory and exports. Managing inventory is something that traders watch closely. Inventory has fallen to a point that requires a build up over the next few months. At the same time consumer spending has gone up putting more pressure to increase inventory. Inventory building will mean a better GDP number in the future. All that is in the future and of course that is exactly what stock investors and traders react to.

On Thursday Chrysler’s bankruptcy was announced by President Obama. This is a good thing. We need to let the bankruptcy laws work. It would probably be better to let other companies file for bankruptcy as well. Did we need to save the banking system? The answer is yes. Do we need to save any other industry? The answer is no. Even in the banking system those responsible for the failed banks need to be punished, but the system needs to be supported for the short term. The real question is how long and how intrusive will the government be in private industry? One of the biggest U.S. criticisms in recent years has been foreign government involvement in foreign companies. Those companies with government backing were seen as unfairly competing with private industry. Now we, in the U.S. are doing the same thing. It damages the U.S. argument that we let free enterprise pick the winners and losers and not support otherwise failing companies with government dollars. That seems a bit hypocritical.

This morning, Friday, a stronger ISM (Institute of Supply Management) indicated that the industrial sector is picking itself up. It is still shrinking but improving. This was the fourth month in a row of an improving ISM report.

No matter what spin you put on it, the stock market is telling us that things are going to get better for the economy. History tells us that over the next year or two there will be a rally of over 50% in the stock market. This will not be a march straight up in prices. Expect pullbacks and use them to buy. Do not let fear control your decisions.

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On Friday I wrote about the fear of inflation but also stated that maybe a little inflation is not all bad, and indeed it is preferable to deflation.

Rising prices are always hard on us consumers as many times our incomes do not keep up. So why would inflation be preferable to the alternative which is deflation where prices fall? One very strong reason is that in a deflationary cycle, consumers stop spending. They postpone purchases in an effort to wait to buy lower priced items as they fall month after month. This happened in Japan in the lost decade from 1990 to 2000 where their entire economy shrank.

Also, and just as is important, is as the government takes on trillions of dollars in debt, and that is a lot of money that no one can really visualize, it is much easier to pay that debt off in inflated dollars down the road. With deflation it is much harder to pay off.

If dollars become less valuable, the cost of paying off debt is less. If you buy a house and make a $3,000 a month payment with a 30 year fixed mortgage, in 20 years with inflation that $3,000 dollars will feel much less burdensome. That is inflation at work. The government has the same issue except their mountain of debt is a much bigger problem.

A little inflation is a good thing. A lot of inflation destroys wealth.

Good Trading
Steve Peasley

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The trend in the DOW is certainly down and breaking down to new lows. The other indexes are not far behind though they have not fallen below previous lows made last year. Everyone is feeling that the economy is not going to recover anytime soon and the stock market has been leading the charge in that sentiment. There certainly has been no bounce from the new administration. President Obama’s stimulus package has hit the public with a loud thud. When the President himself expresses little confidence in it working how you do think the rest of the public, including the stock traders, are going to feel?

On another note, the government has said that they stand by the big banks and are not interested in taking ownership. At the same time Citigroup is in talks with the government in which Citi would give up to 40% ownership to Uncle Sam in exchange for a cash infusion. That may not be outright ownership but it certainly would constitute controlling interest.

Uncertainty and fear reign and until that changes there will be no sustained rally. We will likely have a relief rally from an oversold situation, but when and how much is a difficult call.

On a brighter note, the economy will recover and there are some small signs that the recession is lessening its grip. Small signs are much better than none. The turn is coming and the stock market is looking for any sign of it.

Good Trading
Steve Peasley

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New home construction fell to a 50 year low as reported this morning. It could be worse than that as they only started counting 50 years ago. At the same time applications for mortgages last week spiked up by 40% or so over the week before, most of it for refinancing of course.

Today, Obama released his plan to save some people from foreclosure and the market didn’t really care much for it. So far the Obama Presidency has been a large disappointment from a stock market point of view. He does not really pay much attention to the industry, having repeatedly complained about the excesses of Wall Street. However, the stock market is a leading indicator of our economy. It is telling anyone who wants to listen that it does not see an economic turn around as yet.

It is time to be very cautious, holding significant amounts of cash on the sidelines with a few contra positions for protection. If you are going to own stocks, dividends are important as they will give you a cushion. Of course you need to be concerned that the companies you buy can maintain their dividend.

Most traders are waiting to see if the market will break the September lows. We are very close and it’s touch and go at this point.

Good Trading
Steve Peasley

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