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Investing for the New Millennium
A monthly newsletter for CANSLIM.net Premium Members that recaps the technical highlights and current headlines of today's top stocks and moving market sectors. Each issue contains educational studies aimed at helping you to build trading skills and gain knowledge. It also will keep you abreast of current financial news that could be worth taking action on.


Should Investors Be Critical of the Fed?
For CANSLIM.net by Kenneth J. Gruneisen

Vol. 2, Iss. 1
January, 2001

Many vocal critics of the Fed have claimed that Greenspan and his cohorts fought an enemy that was not there. That enemy being inflation! But, while energy prices surged and labor markets remained tight it was indeed a very worthy concern that inflation could become problematic. Where one might take issue with the Fed, however, is another story.
 
First, understand that it has only been a recent policy of the Fed to forecast, in some degree, the outlook for future changes in interest rates. By announcing a rate bias at their meetings, they hoped to avoid surprising us with unexpected moves. There are those who would have liked to see a rate cut at the most recent FOMC meeting on December 20th, however, such a move would have created a serious credibility problem for the Fed. They came into the meeting with a tightening bias, so a cut in rates (even if it was the right thing to do) would have blown our policymakers future credibility, and would have likely undermined investor confidence even further.
 
One can only wish, in retrospect, that the Fed had taken the signs of economic slowdown that were clearly present in November as a reason to move to a neutral bias. Then, they would have been able to move either way on rates and still keep their credibility intact. The good news is that they are headed in the right direction now. With an easing bias, the prospect of lower interest rates should lead to a more optimistic market tone.
 
Tax selling has recently pressured the market and limited its upside, while investors have also grown more cautious of the slowing economy and its impact on corporate earnings. In the near term, making it through the upcoming earnings season could be a challenge. And despite the market's extensive losses, bargain hunters have not been aggressive in stepping up to the plate. The effect of any future interest rate reduction should also be expected to take some time before it is realized in the earnings department. Meanwhile, it is virtually unanimous that more earning warnings lie immediately on the horizon.
 
Bear markets work to shave off the excesses that were created in the previous bull market. Valuations have already been trimmed substantially, as the average P/E for S&P 500 stocks has dropped from 40 to 25 throughout the present bear market decline.
 
Before we would say that it is time to give up and run to the hills, however, there are some positive things happening that are worthy of note. First, the small cap Russell 2000 Index gained 3.07% on Thursday, December 28th, closing at 494 after breaking above a 4-month downward trendline. That was a very bullish sign, especially after holding firmly above the 440 level which has been a solid floor for the past 10 months. Support has kept the Russell 2000 above 440 thus far, but any failure below that level would indicate deeper troubles for the broader market of small stocks (which are typically stronger performers during this season). A breakdown below that point would technically indicate that small stocks are likely to suffer for an even longer period of time.
 
The fact is, however, that the recent bullish break above a 4-month downtrend indicates that a broad array of smaller stocks are not plunging to new lows, but actually starting to perform better. A longer-term downward trend from the highs remains intact, however, and investors should continue to use caution until we see a break above that long-term trendline. The Russell 2000 Index includes many of the small bank stocks presently making up a fair portion of the recent market leadership. 
In fact, strength in the NYSE Financial Index is growing clearer, as its latest break to new highs from a 4-month base followed through nicely. Talk of lower interest rates yet to come has helped the smaller bank stocks develop into a real hotbed of trading activity, largely due to their obvious sensitivity to interest rates. For the time being, concerns about bad credit risk and the increasing number of loan defaults are apparently being brushed aside. As long as financial stocks remain strong, however, the outlook for the market is not entirely bad.
 
Another recent positive has been the frequently positive breadth on both exchanges, but particularly the NYSE. New highs have outpaced new lows on the NYSE by approximately 2-to-1 over the past 3 weeks, providing more clues as to where things could be headed.
 
Investors are ready to put the year 2000 behind them, having been the first time since 1990 that the Nasdaq, Dow, and S&P 500 all ended the year on the down side. In fact, the Nasdaqs steep 39.2% decline for 2000 was disproportionately bad when compared to the Dow and S&P 500, which declined 6.1% and 10.1% respectively for 2000. Of course, Nasdaq had also enjoyed a disproportionate run up that immediately preceded 2000s record one-year percentage decline. Blue chip stocks have generally benefited while hesitant investors have been unwilling to aggressively commit to buying smaller companies. With ongoing concerns about corporate earnings, investors have favored defensive positions as safe havens.

In addition to the fact that interest rates are headed lower, President-elect Bush is proposing tax cuts that could also have a more immediate positive impact on the market. There is a growing consensus that a recession is likely in 2001, and the Fed appears to be behind the curve with its efforts to stimulate growth. The likelihood of a hard-landing has also created the expectation for an easing of rates possibly before the January 30-31 FOMC meeting. 


- END -

Read Kenneth's Previous Articles

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Comments contained in the body of this report are technical opinions only and are not necessarily those of Source Capital Group, Inc. The material herein has been obtained from sources believed to be reliable and accurate, however, its accuracy and completeness cannot be guaranteed. Our firm, employees, and customers may effect transactions, including transactions contrary to any recommendation herein, or have positions in the securities mentioned herein or options with respect thereto. Any recommendation contained in this report may not be suitable for all investors and it is not to be deemed an offer or solicitation on our part with respect to the purchase or sale of any securities. Source Capital Group, Inc. is a NASD/SIPC member firm.