Deep Impact?

Since the March 12 reversal, the markets have had a “fast and furious” ride, gaining more than 25% in 3 months. Today, we evaluate the factors influencing the markets to guesstimate their future impact on equities.

• Window Dressing: The decorating period ends today. The best quarter since the Bear Market began in March 2000, hedgies and mutual fund managers are not going to let their performance numbers and bonuses slip away. (+);
• Where the Bears? With 71.4% Bulls, and nary a Bear in sight (Only 8.6%!) this is the highest bullish percentage since the all-time peak of 75% on Jan. 6, 2000. We need not remind you how that enthusiasm ended. (-);
• Overhead resistance: Indices are at levels where a pullback/consolidation would be healthy (chart at right) (-);
• Downside leadership: Watch the upside winners to see how far we go down — Semis, financials, housing, biotech, & internets led the move upwards; Whether they show good relative strength or lead the markets during the pullback will be telling to the next phase. (+/-);
• Lack of Credible Alternatives: Where else can investors put their money? Bonds are peaking after a 3 year bull run, and money markets pay less than 1%; Equities have become the only game in town. (+);
• Terrorism: Will the terror alert level be raised to Orange for the July 4th holiday? How investors react to the color change (Have they become inured?) is worth watching (-)

Two last issues are worth thinking about: First, predictions that tax cuts will significantly stimulate the economy, starting this Summer, are likely overestimating their net impact. ‘Though the tax cut was substantial, it was mostly hi-income loaded; Actual additional dollars finding their way into the “spending classes,” (i.e., the lower and middle income groups) is de minimus. While it will have an impact via increases in the saving/investing rate of high net worth individuals, it will not cause a huge spending spurt. Economists are counting on big gains of increased consumer spending; Their overestimations will likely leave the dismal scientists – and the economy – somewhat disappointed.

Second, the Fed rate cutting cycle is now over. Although nearly free money will continue to chase cash out of money market & bonds for some time, the psychological edge of having an accommodative Fed is fast fading. Greenspan’s next move will likely be to raise interest rates, lest the economy starts to overheat, near December 2004.

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