The Fed also said they would consider launching a bond-buying program and it wouldn’t wait for a recession to do it. Fed Chairman Ben Bernanke hinted he would act if the economy and unemployment simply continues to recover at its present slow pace. At the same time, the Fed dropped its forecast for economic growth this year from a range of 2.5%-2.9% to 2.2%-2.7%.  He also targeted a 2% inflation rate for the country but also said that he would be willing to see inflation a bit higher if it meant producing more jobs for Americans.

What all of this means for you and I is that the Fed is determined to do all it can to goose the economy, the stock market and the housing markets. In the past, when the Fed conveyed this kind of message to investors, the stock markets climbed higher. I expect the same thing to happen again this time.

It is not yet clear to me how telegraphing their determination to push longer term rates lower over the next two plus years is going to help home buyers decide on purchasing, as opposed to renting. If, for example, I was in the market for a fixed rate mortgage and I know rates might trend lower between now and 2014, I would be in no hurry to sign a contract.

The Fed’s announcement is also bad news for those retirees who have fled the stock market and have their money invested in “safe’ assets such as CDs and U.S. Treasury bonds. They will continue to receive next to nothing for their money while struggling to make ends meet as food, energy, medical services and other necessary living expenses continue to rise.

On the plus side, investors can be pretty sure that the economy won’t get any worse and that the stock market is about the only place one can hope to achieve a reasonable rate of return on your investments. Of course, there will be the inevitable piper to pay down the road but central banks around the world have decided to worry about the inflationary consequences of trillions of dollars in stimulus when it happens.  Future inflation fears is one reason that commodities led by gold and silver raced higher after the Fed meeting.

So do the Fed’s actions change the bottom line of my investment strategy? Not really. I believe defensive areas of the stock markets (those stocks and sectors that pay dividends) will do just fine in this environment. High yield and investment grade bonds will also do quite well. We will still have pullbacks in the market this year and some of them might even be serious. Overall, I believe we are exactly where we should be.

Markets will do what is most inconvenient for the most number of investors

Why now? Haven’t these same issues been with us for months? Yet, the same news on Greek debt negotiations that in the past sent stocks into a downward spiral is now simply being ignored. The continued delays in EU progress toward a monetary and fiscal solution to their financial crisis are now greeted calmly rather than with horror.

Some of the market’s response can be attributed to a “no news is good news” read on events in Europe. That leaves investors to focus on the positive data coming out of the American economy, something I have been writing about for months. The data continues to improve. We are actually hearing some analysts who now believe the fundamentals of the housing markets are improving.

There is also the recurring story, first identified by me in a September column “What the Market Missed”, that the administration is planning a big mortgage refinancing operation with the Fed’s assistance. Anywhere from $1-3 trillion worth of U.S. mortgage holders will be able to refinance their high interest bearing mortgages at lower rates, injecting billions into home owners’ pockets. 

However, all this good news has been quickly reflected in stock averages. Financials, which have been under constant selling pressure for well over a year, have suddenly rallied big in the last three weeks. Home builders have also jumped by over 10% in some cases in the same time period. Technology stocks overall are on a tear, despite some lackluster earnings announcements. The benchmark S&P 500 Index is already up over 5% so far this year and we are only now entering the third week in January.

Most indicators are flashing amber or red warning lights indicating the markets are overbought and due for a correction. I agree, although markets can remain overbought for a long time and still plow higher. When I look at the potential downside, I am not too concerned. Sure, we could drop a good 50 points or so in quick order on the S&P but that’s about the extent of the downside I see right now.

If I put that in perspective, there were days last year when that kind of decline was almost a weekly occurrence. All week trader talk focused on when the correction would occur and how much the averages would decline. Unfortunately for them, markets will typically do what is most inconvenient to the most number of players.

And that’s what happened this week. As traders positioned for a sell off, they were continually disappointed, the pullbacks were shallow and the markets grinded relentlessly higher, despite the worries.

Make no mistake, the good times will end but the trend over the next three months in the markets is up. So enjoy the ride short-term and don’t worry too much about the inevitable pullbacks, at least for now.

Europe is back on the front burner

It was almost comical to watch the talking heads this week as they tried to make a case that the U.S. markets were decoupling from the troubles in Europe. They highlighted the increasingly positive economic data, the possibility of quarterly earnings surprises and the hope that the Fed was preparing for another round of quantitative easing.

My take is that Europe has a longer holiday season than we do. Their movers and shakers just got back to work this week. We haven’t decoupled. There was simply an absence of market making news until this week.

All of that decoupling talk disappeared on Friday as a rumor surfaced that credit rating agency Standard & Poor’s was ready to downgrade a slew of European countries this weekend. At the same time, JPMorgan’s revenues disappointed the market in their earnings announcement, sending the entire financial sector into a tailspin. Retail sales for December (as I predicted) also disappointed the markets. The holiday season failed to live up to retailers’ expectations triggering fears that future economic growth was in jeopardy.

My advice to readers is to ignore all these one-off events. The simple truth is that we have benefited from A) The Santa Claus Rally and B) the January Effect. In my last few columns, I explained both and predicted the markets would rally as a result. Both A and B came off like clockwork and are now about over, leaving the markets vulnerable to a pullback.

I’m not looking for anything disastrous to develop, outside of a normal two-steps -forward, one-step-back kind of decline. There are too many positive developments for me to become overly bearish.

Both Italy and Spain managed to sell 17 billion worth of sovereign debt ($21.5 billion) this week without too much trouble. That was a vast improvement over last month when few players were willing to even look at buying bonds from these countries. The European Central Bank left rates unchanged, leaving the door open for possible rate cuts in the future. Even Greece, the bad boy of Europe, is stumbling towards a debt deal in their typical on-again, off-again fashion.

There is also a lot of talk about the possibility that the Fed will launch QE 3 sometime in the next few months. This is partially a result of some dovish sounding speeches from several Fed members lately. I have my doubts. As long as U.S. economic data continues to improve, I don’t think the Fed sees the need for additional monetary stimulus right now.

Of course, we are in an election year and sitting presidents in the past have been known to “lean” on the chairman of the Federal Reserve to goose the economy as November approaches. I think it is still too soon for that kind of monetary monkey business before the elections. But it does help buoy the mood of investors so we will put that in the plus column.

In summary, the markets will pull back and then go higher. That will be a trend I expect will continue for the next several months. I’m not looking for big gains, just a general trending higher by the indexes, interrupted by pullbacks on a periodic basis. The upside could lift the S&P 500 Index to the 1,350 level but from here that’s no more than a 5% gain from here. As such, we will keep one foot in dividend paying stocks and the other in the fixed income market. In other words stay defensive.

As expected, the good news coming out of the U.S. economy has encouraged investors, while higher yields on Italian sovereign debt provided a counterweight that leaves the markets in a tug of war. The lack of news out of Europe allows investors to pay more attention to American data, such as the drop in the unemployment rate to 8.5% from 9.4% this time last year.

Beginning next week, however, European players should be back from their chalets in Switzerland or Spain and the fun begins all over again. At the same time, we face another earnings season and if earnings are not up to investor expectations we could definitely see a sell off.

Alcoa, the aluminum maker, kicks off the earnings season after the close on Monday and the company has already warned that higher costs and declining prices are threatening profits. Retailers admitted that Christmas sales were not as strong as they had hoped. I had warned readers not to fall prey to the holiday season hype on how great Christmas sales would be for retailers. Those who did best were those that offered thrifty consumers massive discounts off list price.

Short term, absent any new positive developments out of Europe, we could see some profit taking in the weeks ahead. That should be no surprise to investors, given my outlook for 2012. In yesterday’s column “2012 could be another up and down year” I outlined the risks and opportunities we face this year. To sum up, I expect a choppy first half with a possible ‘sell in May and go away’ scenario. The second half could be better, thanks to election excitement and hope for a more functional Congress and Senate.

I also warned that any number of unknown events ranging from what happens in Europe, The Fed’s monetary policy, and actions (or non-action) out of Washington could make any forecasts, including my own, worthless.

Take, for example, this week’s rumor (later denied by the White House) that the Obama Administration is planning a mega refinancing ($1-$3 trillion) of the American mortgage market.

Back in September, I wrote in “What the Markets Missed” that such a plan was being debated within the White House. The program would not require congressional approval and could be conducted largely through the Fed, the FHA, Fannie Mae and Freddie Mac. It is an election year, after all, when the sitting President will do all he can to stimulate the economy before the elections. That type of left field developments has the power to dramatically alter the market’s expectations.

The cross currents within the markets remain. As such, I will stay defensive with a large percentage of my portfolio sitting in bonds and dividend yielding stock funds. I will let the markets dictate my next move or when to become more aggressive. In the meantime, expect volatility.

“I always sell my equity positions whenever the S&P 500 Index trades below the 200 Day,” says a trader friend of mine, “and I don’t buy back until it rises above that level again and stays there for more than a week.” 

It is a rule of thumb that has worked for market timers (those who try to sell the rips and buy the dips) more times than not since 2007, but it is not foolproof.  There have been times in the past when stocks fell below that level only to rebound and continue much higher. Nevertheless, many traders take the 200 DMA very seriously. As a result you should too.

Every index has a 200 DMA whether you are looking at stocks, bonds or commodities.   Most investors focus on the S&P 500 as their key average when trying to read the tea leaves in the stock market. Today, the 200 DMA is trading roughly at the same level that marks a gain or a loss for the S&P for 2011. The S&P Index started the year at 1,257.64.

The 200 DMA is right now about 1,259 (although it will change since it is a moving average). Several times over the last few months bulls have attempted to break that line, but the resistance has been fierce. Each time the bears have thrown back the bulls’ advance decisively. So here we are again at the resistance line, but the Santa Claus rally has been fairly weak and prices have advanced on low volume.

Clearly, there is little we can read from the closing values of the S&P Index for the year. Given the enormous volatility investors have experienced, a gain or loss of 3-4 points and a close above or slightly under the 200 DMA is meaningless. It gives no guidelines for what will happen next.

On the bright side the U.S. has done much better than other global markets. The main markets in Europe have suffered their worst losses since 2008, thanks to the continuing financial crisis.  In Asia, the once-hot Chinese market dropped 21% for the year while Japan had its lowest close since 1982.

Their performance reflected a year that was plagued with natural disasters from earthquakes to floods, the Arab spring, trading scandals, wild rides in commodity, the complete dissolution of political leadership on both sides of the Atlantic and a continual widening between the “haves” and “have nots” around the world. 

Bond prices, especially in our U.S. Treasury markets, were one area of positive gains. Prices continued to rise, despite the downgrading of our sovereign debt.  Investors, spooked by the gyrations in the stock markets, flocked to this perceived safe haven.  However, thanks to the low rates of interest, yields in that market have in some cases turned negative, such as Treasury Inflation Indexed bonds (called TIPs).

Today, a 30-year Treasury bond is yielding 2.9% while the Consumer Price Index, the nation’s inflation gauge, has been running at a rate above 3%. At those rates, retirees who need income to simply stay afloat are not even breaking even with inflation.

I find it impressive that, despite the gut-wrenching turmoil, the U.S. stock market has held its own and is finishing even-to-up in the case of the S&P 500 and the Dow. It appears most of the bad news of 2011 has been discounted. Who knows, we may actually break that resistance and climb above the 200 DMA on the S&P 500. That may turn out to be my ‘famous last words’ but I remain somewhat optimistic. Despite the unknowns, I sincerely wish all of you the same joy and happiness you have given me this year. Happy New Year!

Waiting for Santa

In a recent radio interview, the host complained that the bad news just keeps on coming. If it isn’t Europe, it’s the embarrassment of our own political leaders in Washington. If that wasn’t enough, we have tensions in Iran, North Korea and Syria. Yes, I agreed, all of the above is true and yet the stock markets are essentially unchanged from where they were a year ago. 

Reading and listening to the chatter that at this time of year is largely focused on what’s next for investors, I find a great deal of confusion. Most strategists are caught up in the continuing gloom and doom pessimism that has pervaded the markets throughout the year. This is despite the fact that the U.S. economy is growing at a rate higher than anyone expected.

No matter where you look—technical charts, momentum, fundamentals—it appears we are heading lower in 2012. Conventional wisdom has it that Europe is heading for a steep recession, China a hard landing and the U.S. by default is dragged down with them. In which case, the stock markets go lower.

After more than a year of faulty starts and disappointments by European leaders, most investors discount any new initiatives coming out of the EU as too little, too late. The joke that we call leadership in Washington D.C. is also well known. And that’s my issue with the bear case. Everyone knows how bad it is—investors, the Fed, politicians, even Main Street. When a crisis is as well known as this one, it is usually addressed.

 In my opinion, it is a mistake to get sucked into this malaise. The Europeans are making progress in solving their financial crisis. Granted, we may not like their half-measures, their delays, their posturing and constant policy reversals but in the end things are getting done.

Bond yields in Spain and Italy are coming down. Banks are no longer in danger of going belly-up. The central banks of the world are on record that they will not let the EU or the Euro fail. Just this week the European Central Bank loaned $640 billion in low-interest rate loans to their banking industry. There will be more of the same in the weeks and months ahead. It may not be enough to save Europe from a recession but it could well limit the severity and subsequent damage to the U.S. and the rest of the world.

Pessimism abounds wherever you look and that, my dear reader, should make you sit up and take notice. It is times like this when we have our best rallies. It is times like this that the smart money stays put and does not give in to the overwhelming gloom that is assaulting us at every turn. As a self-confessed contrarian, I remain somewhat bullish on the markets, if not hysterically so.

My strategy is to watch and wait between now and the end of the first quarter. December and January are normally the strongest months of the year. If the Santa Claus rally fails, followed by a down first quarter of 2012, then I will throw in the towel and get much more defensive. Until then I will give the markets the benefit of the doubt even if I keep my enthusiasm on a short leash.

Merry Christmas to all and to all a good holiday weekend.

Where is he?

There are many explanations for why markets sometimes move higher between Christmas and the New Year and into January. One reason is the “January Effect”. Historically (since 1925) markets have risen in the first month of the year with small caps leading the way. Investors like to get in the market before that move begins, usually during the last week of the year.

 Since 1896, the Dow’s average monthly return in up years has been roughly 0.5% but Decembers have returned 1.4% overall. Some believe that tax considerations drive the markets during this time. Investors, for example, who sold losers earlier in the month, now begin to replenish their portfolios with new buys. There is also the fact that many employees receive their year-end bonuses, either in December or January, and invest those proceeds into the markets. I wouldn’t discount the psychological impact either. Good feelings, generated by holiday cheer, and the absence of Grinch-like pessimists, who are usually on vacation at that time, spill over into the stock markets..

Yet, not all years have produced Christmas rallies and many Decembers have actually lost money for investors. Given the steady stream of bad news coming out of Europe one would expect that any rally we may have will be somewhat subdued.

For most of this week the markets have tried to rally, largely on good news generated by the U.S. economy. On Wednesday, Thursday and Friday morning’s stocks were bid up by one percent or more only to flounder when comments out of Europe cut the gains to just above breakeven. As expected, the sniping began on Monday, almost as soon the EU agreed to expand and police a new fiscal austerity effort among its members.  The naysayers were eager to explain why the agreement would be difficult to implement or just plain won’t work.

Rumors all week that the credit agencies were preparing to downgrade sovereign French debt to ‘AA’ from ‘AAA’ has also kept a lid on our markets. On Friday, Credit agency Fitch actually downgraded its outlook on France to “negative” but kept their ‘AAA’ rating. It also put Italy, Spain, Ireland, Belgium, Slovenia and Cyprus on negative watch.

Traders have been watching the Euro, selling stocks as the Euro-Zone currency declines and the dollar moves up and then reversing the trade on any strength in the Euro. They argue that the Euro’s decline signals worse trouble ahead for the EU and therefore for America and the rest of the world. No one seems to recognize that the Euro’s decline actually helps the economies of Europe (making the goods they sell cheaper to overseas buyers), especially in places like Italy and Spain, where exports are a big part of their overall economies.

One wonders when investors are going to decouple from their manic focus on Europe and concentrate instead on the U.S. market where stocks are cheap, unemployment is declining, and the economy growing. It is my hope that it will finally dawn on the markets that there’s no place like home, especially for the holidays. In which case, there may be more under the tree than most investor’s expected.

Despite these weekly doom and gloom predictions, the markets have weathered the storm. Consider these “end of the world” moments: the U.S. debt ceiling, the budget debate, the lowering of our credit rating; while in Europe there have been dozens of do-or-die deadlines from Greek default to this weeks’ EU summit. How long must the wolf cry before we become inured to its call?

The truth is that the media and many of its guests see things in such simplistic terms that either/or is about all they have time for. Real life, as we know, is much more convoluted and complex than that.

Sure, there may come a time when once again (like in 2008-2009), the problems that besiege much of the world’s economies will come home to roost. But, if human nature holds true, it won’t happen until we least expect it. Since, if we expect something terrible to happen, we will do all we can to avoid or fix it. That process, my dear reader, is what is occurring right now throughout the world.

So if you were thinking that European leaders have finally resolved their financial crisis, think again. Friday’s EU agreement moves them another step closer, but we still have a long way to go.

Twenty-six European nations agreed to forge a new treaty in order to establish an even closer fiscal union, one that will force members to get their fiscal house in order or “else.” Presumably, “else” would mean that members who fail to toe the line will be booted out of the union. Great Britain, which rejected the Euro in favor of its own currency, the British pound, in the original treaty, was the only member country that refused to join the agreement.

Drafting that agreement, ironing out the fine details, and ultimately passing it should be a guaranteed source of additional volatility as the debate continues. Although the fiscal integrity of several European nations was the source of the financial crisis, this fiscal initiative does little to solve the symptoms of the crisis. Those symptoms – huge debt loads, escalating sovereign interest rates, high unemployment, slowing economies and concern over the Euro — are still of immediate concern.

These worries will be with us for the foreseeable future and, left unaddressed, could sink the markets. But remember, just two weeks ago, several of the world’s largest central banks announced their intention to establish a floor under this crisis in the form of massive monetary intervention when necessary.

Over here in America we have our own issues. On the fiscal front, our do-nothing Congress and Senate guarantees there will be no additional economic stimulus unless President Obama can pull something out of his hat that does not need congressional approval. Monetary policy is on hold as the Fed waits for further clues on the economic health of the U.S.

This particular wall of worry is indeed quite formidable. Some investors have decided to just move to the sidelines until this volatile period subsides, and I don’t blame them. If concern over your investments is keeping you up at night, you are too aggressively invested, in which case change your allocation.

As I warned in my last column, we saw a lot of volatility in the markets this week. Expect more of the same in the weeks to come. That said, I believe we will move higher between now and the New Year.

Next year, however, may be a different story entirely.

Bears down but are they out?

In last week’s column I urged readers to hang tough. Call it blind faith or just an intuitive feeling, I suspected that good news was just around the corner. It was. Several of the largest central banks of the world coordinated an emergency rescue plan to loan dollars to banks in Europe. At the same time, China made moves to boast their faltering economy. For those who missed it, please read this week’s column (“Central Bankers Backstop Global Economies”).

But that is only Phase One of what I see as a coordinated effort by governments to staunch the flow of panic and selling in financial markets. It is no coincidence that rumors of a new deal involving both the European Central Bank (ECB) and International Monetary Fund (IMF) surfaced on Thursday and Friday. In a quid pro quo offer, the ECB President Mario Draghi hinted that the bank could take on a bigger role in bailing out troubled Euro Zone countries if the EU members force additional fiscal discipline on an on-going basis. Most investors believe that the EU is the only institution large enough to contain the expanding financial crisis.

On this side of the pond, we also have had a bit of good news. The unemployment rate dropped to 8.6% versus an expected 9%. The headline numbers were in line with expectations, but last week’s data was revised upward. These upward revisions are occurring with increased regularity. It supports my conviction that investors should be focusing on the continued improvements we are seeing in our own economy. Instead, we are so myopically focused on events in Europe that we can’t see the forest for the trees.

The U.S., for example, was one of the few countries that saw its manufacturing output increase in November. Thanksgiving retail sales were also greater than analysts expected, raising hopes that consumers might deliver a boost to the economy in time for Christmas.

All this good cheer has pushed stocks higher. The next European event investors will be focused on is next Friday’s December 9^thsummit meeting of European Leaders. I expect a week of “she said, he said” statements coming out of Europe. The Fatherland’s Angela Merkel will most likely continue to tow the German line of austerity first, bailout second. Other more dovish nations, led by French President Nicolas Sarkozy, will be sending up trial balloons of a more positive nature.

This on-going drama should set the stage for continued volatility as markets respond to every word, rumor and hiccup that surfaces. As a result, I remain in defensive mode. A failure in Europe could easily erase all the market’s gains once again so it is still not time to become more aggressive. Our gains may not quite match the markets overall, but neither will they fall as far as the markets on disappointment.

            Germany’s Chancellor Angela Merkel agrees change is necessary but not the kind the markets want.   Her nations insist that good old fashioned fiscal austerity will solve Europe’s problems over time.  Investors believe that while that is a laudable goal, it will not do anything to solve the immediate problems of the “too big to fail” nations such as Italy and Spain. 

Over the last two weeks the flow of positive comments from European leaders who keep promising a definitive solution has subsided. During that time it has become clear that Germany is unwilling to go along with the majority of EU member nations that want the European Central Bank to act as lender of last resort.  As a result, the price of European debt and equities has declined while interest rates have reached untenable levels in Italy and Spain. Even German sovereign debt is not immune. This week’s 10-year note auction was woefully undersubscribed with only 65% of the issue taken up by investors.

Over the last month I have written that the “She said, he said” strategy of talking the markets up while trying to come up with a solution to the Euro Zone problem would only work  for a short time. Without a substantive plan to bail out Italy and Spain, et al, investors would lose patience with Euro Speak. That is now happening and the best that Europe’s leaders could come up with is to promise not to criticize each other in public.

The bottom line is that Germany is the largest, wealthiest, most politically stable member of the EU.  It owes that success, in part, to the Euro. Its economy has benefited mightily from the currency. Today, without Germany, there would be no European Union and the Germans know it. 

As such, the Germans insist that there will be no U.S. Fed –style bailout of European nations with the accompanying risk of hyperinflation. It was never part of their vision. Some believe that they would rather see the EU dissolve first. It appears the markets are intent on forcing Chancellor Merkel into deciding which is most important– Germanys’ principles or the EU. 

In the meantime, the U.S. markets are deeply oversold. So it was no surprise that Friday’s holiday-shortened session experienced a bounce in the averages.   Investors, after days of Europe mania, focused instead on America and its Black Friday weekend consumer spending spree. The markets are hoping that consumers will forget their woes this weekend and spend, spend, spend.

I do believe there will be a boost to retail spending this year, but after the smoke and hype clears out, the revenue numbers will not be as high as some predict. If spending follows the trend of last year, expect a boost in sales for the holidays now, followed by a decline before picking up again just before Christmas.     

I am expecting a nice bounce in the markets into the end of the year. Granted, the averages have gone the other way since last week and have retraced two thirds of October’s gains so far this month. Let’s hope December lives up to its name as the best month in the year for stocks.