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Sunday, March 9, 2008

Now What? The Week Ahead

Last week’s performance was pretty much in-line with our expectations, as outlined in our March 2nd post. But what’s going to happen this week? The beginning of this week is going to be relatively quiet on the data front. However, we will be ending the week with some important consumer related data including CPI, Retail Sales, and Consumer Sentiment (See calendar below).

Nevertheless, the main question this week will be whether or not the Fed cuts rates before the March 18th meeting and if so by how much. First the easier question, we anticipate the cut will be 75bp. Now the harder one, we think that we are close enough to the March 18th meeting for the Fed to wait. However, this will be very market dependent. If the market experiences a significant sell-off, then we are likely to see the Fed to act early. Typically, when the Fed delivers unexpected news (such as a rate cut) it usually occurs between 8:15AM and 8:30AM, so please be on the lookout if this scenario does plays out.

If you believe, like us, the Fed would intervene to stem any significant sell-off, then this week could turn into a good buying opportunity. Essentially, the potential Fed rate cut would work as a partial hedge against market risk, not a bad deal. The Fed has a tendency of not disappointing market expectations, and this will not change in the short-term, especially now. So if the market does experience a significant sell-off we would expect the Fed to act (as they did on Jan. 22nd) and potentially generate at least a short-term rally (See chart below for SP500 performance during the Jan. 22nd cut). At the same time, if the market does not experience a sell-off, the increased likelihood of a 75bp cut at the next Fed meeting should help bolster market performance.

S&P500 performance during Jan. 22nd inter-meeting rate cut

Market performance will remain very dependent on news from the financial industry and economic data releases. Here are the economic releases that could affect the market this week:

Monday March 10th:

Tuesday March 11th:
8:30AM: International Trade (Risk: Neutral)- According to Bloomberg.com the market is currently expecting a trade deficit of USD59.5bn vs. USD58.8bn last month.

Wednesday March 12th:

Thursday March 13th: Key Day in a Quiet Week
8:30AM: Retail Sales (Risk: Slight Upside)- According to the consensus survey Retail sales are expected to increase 0.2% M/M for both the headline and core reading. There could be some upside to this release from better than expected sales figures for discount retailers such as Wal-Mart

8:30AM: Import Prices (Risk: Slight Downside)- Bloomberg.com currently states a market consensus of +0.6% M/M change in import prices. Increased commodity and food prices will continue to put pressure on import prices. The big concern is how strong the pass-through effect will be to the overall CPI.

8:30AM: Jobless Claims (Risk: Downside)- Bloomberg.com currently states the market is expecting a reading of 358K. We find this to be one of the most important indicators for the health of labor market. Given continues weakness in the labor market, and signs that the commercial construction industry may be on the verge of slowing; we believe this number has the potential to surprise to the upside. Basically, any reading below 350K is considered relatively healthy, and above could warn of a recession. The 4wk moving average currently stands at 359,500. Non-farm payrolls tend to be a lagging indicator of overall economic health, while jobless claims tend to be a leading indicator, hence its importance.

10:00AM: January’s Business Inventories (Risk: Neutral)- The consensus survey expects business inventories to increase 0.5% M/M.

Friday March 14th:
8:30AM: Consumer Price Index (Risk: Neutral/Slight Downside)- The consensus survey is expecting a 0.3% and 0.2% M/M increase in CPI and Core CPI, respectively. Growing food prices, high commodity prices, and a weak dollar will continue putting upward pressure on CPI. However, how much of this will be nullified by decreased demand is yet to be seen. For more on the importance of inflation and Fed Cuts please see our Feb. 27th posting (http://fiateconomics.blogspot.com/2008/02/fed-cuts-inflation.html).

10:00AM: Consumer Sentiment (Risk: Downside)- The market is currently expecting a reading of 69.5 after experiencing a free fall last month to 69.6. Given last month’s drop it is hard to make an accurate measurement, but we believe it is likely to come in below current expectations.

*Investment Idea:

We believe the fact that the Fed has always delivered news of inter-meeting rate changes to the market at around 8:15AM EST can be used to our advantage. Take this for example, if the market experiences a significant sell-off and an inter-meeting cut seems likely, you could purchase futures on U.S. Indices just prior to the 8:15AM EST expected announcement. If the cut does occur, then we should see a rally in future prices, and the position could be unwound within 15 minutes. If a rate cut does not occur, the position could be sold within a very short time frame helping to minimize any losses. Since you are only holding the position for a short period of time downside risk should be relatively mild, while potential upside if the cut does occur could be significant. However, you could face other risks such as negative company or sector news being released while you are holding the position. This notwithstanding, if this scenario comes about we believe the risk is worth the potential short-term gain.

*There is substantial risk in trading futures, so please make sure you know what you are doing! Also, this is an investment idea not advice so trade at your risk.

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