In the last week we have seen all major indexes up strong. The Dow was up over one percent, the S&P up 1.5 percent and the Nasdaq and Russell indexes up over 2 percent for the last week. For the year we have seen the Dow up 9.7 percent, with the S&P up8.3 percent. The Russell and Nasdaq have also showed impressive gains. However what goes up must come down and I believe the bull run in the major indexes will be coming to an end soon.
Fed officials have repeatedly cited housing as a threat to their forecast for faster growth this year.On June 5th Fed Chairman Ben Bernanke said “tighter lending standards for mortgages will restrain housing demand for longer than policy makers anticipated”. Fed officials also viewed inflation as the biggest risk, keeping interest rates unchanged since last raising them a year ago. Economists and investors abandoned forecasts for a rate cut as signs of strength emerged in other sectors.
If the dow keeps this pace up, it will have grown to about an eighteen percent gain for the year pushing the index very close to the 15000 level. I don’t believe the economy is that strong . What is making the market make these gains however are mergers and acquisitions. These are forming at a record pace because everyone is in a rush to do business when the interest rates are relatively low and holding steady. Big business wants to get these deals done before the Fed adjusts rates or before the balance of power shifts in the 2008 elections.
I believe we have come to a situation where the market is overheating and due for a pause if not a correction. The month of May historically ends the best six months of stock gains and this period represents the best trading opportunities for investors. That is why many look to sell in May and go away. I think you can look at last weeks rally as some sort of a gift. The dow as stated before pushed upwards to near ten percent for the year. I am looking at the previous weeks gains as a level of resistance. I don’t think the market will completely do a 180 degree turn but rather consolidate into a less volatile choppy downtrend. Call it a typical summer slowdown. Also weighing in are ridiculous gas and energy prices. Most parts of the country at some point have seen prices hit four dollars a gallon. If some scientific researchers are correct and we do have an active hurricane season especially in the Gulf of Mexico, energy prices will continue to rise. This will be a heavy burden to the travel industry because people will not be traveling as much this summer due to the higher than usual costs to fly, drive, or run the air conditioner. Obviously this has a trickle down effect to the economy something the bulls don’t want to see.
In the end though this rally will be stymied by the Fed. The minutes of the FOMC meeting held on May 9th, 2007 indicated the FOMC found that the risk of inflation remaining too high outweighs the risk of too weak economic growth. Here is an exact excerpt from the meeting. “Nearly all participants viewed core inflation as remaining uncomfortably high and stressed the importance of further moderation. Although readings on core inflation in March had been more favorable, this followed several months of elevated inflation data and price pressures were not yet viewed as convincingly on a downward trend. Most participants expected core inflation to moderate gradually, fostered in part by stable inflation expectations and a likely deceleration in shelter costs…All participants agreed that the risks around the anticipated moderation in inflation were to the upside and some noted that a failure of inflation to moderate could entail significant costs particularly if it led to an upward drift in inflation expectations.”
This just maybe the catalyst that caps the rally in the Dow and S&P at the highs made at the end of May.
Sean Lusk is a registered commodity broker at Manduca Trading LLC. Sean began in the business as a runner on the trading floor during summer breaks from college in 1993. Upon his graduation from Southern Illinois University in 1996, Sean began his career on the trading floor of the Chicago Mercantile Exchange. Overseeing billions of dollars of transactions working as a clerk in the Eurodollar Pit, Sean took the next step and became a floor broker and member of the Chicago Mercantile Exchange in 2002. He handled customer orders for banks and investment houses from all the over world in the Libor pit at the CME. Sean has since moved on to Manduca Trading LLC in 2007 and looks to aid and assist customers in their trading endeavors with his experience and professionalism.
by Sean Lusk
Manduca Trading LLC