Fed Grinds Market Rally to a Halt

It was fun while it lasted, even if it didn't last long. After a day-and-a-half respite from the Florida fiasco, traders were once again forced to deal with the government imposing its will on the market. This time, though, it was the United States' central bankers.

The Federal Reserve decided to leave the fed funds rate at 6.50 percent, where it has been since May. No real surprise here. Most market pundits had expected the Fed to stand pat on interest rates. But what put traders in a selling mood, was the Fed dashing hopes for an interest rate cut in the foreseeable future. In fact, the Fed said that while softer demand and tight financial markets indicate that the economy could continue to grow below its potential for some time, the slowdown has not been severe enough to persuade it to change its view that inflation poses the greatest economic risk to the country.

Many traders in both New and Old Economy issues didn't agree with the Fed's assessment (yours truly included). For most of the day, the Nasdaq Composite Index (COMPX) traded progressively higher to an intra-day high of 3,208.95. However, after the Fed reported no changed in its inflation bias, traders began culling their holdings. Over the subsequent hour, the COMPX lost 104 points to trade at its intra-day low of 3,104.57 before a few buyers entered the market to rally the tech-heavy index 60 points into the close. When it was over, the COMPX was up 27.22 points, or 0.87 percent, to 3,208.95. A workman-like effort to be sure, but nothing compared to yesterday's 171-point, 5 percent advance.

Helping to lift the COMPX out of its post-Fed depression was Sycamore Networks (SCMR), which climbed $4.00 to $68.44. The fiber-optic equipment maker posted a first-quarter profit, reversing a year-ago loss. The company earned $0.02 per share on a pro forma basis and posted stronger-than-expected sales of $120 million.

Another strong COMPX mover was Integrated Device Technology (IDTI), which rose $4.81 to $44.94 after Banc of America analyst Richard Whittington raised the semiconductor maker to "strong buy" from "buy."

Tempering the COMPX's advance was Network Appliance (NTAP), which tumbled $20.13 to $76.13 on concerns EMC Corp. (EMC) will unveil a competing storage system. Additionally, Network reported fiscal second-quarter sales that more than doubled last year's tally, yet the company still missed some analysts' forecasts. I know, I'm beginning to sound like a broken- record on the perils of investing in high price-to-earnings (P/E) stocks, but this thing has a P/E of 400 and was trading at $140 only three weeks ago.

As for the Old Economy Dow Jones Industrial Average (INDU), it also rallied, sold-off and rallied again. The INDU opened at 10,681, which is where it closed on Tuesday. From there, the blue-chip average moved towards its intra-day high of 10,799.37. But at 2:15 PM EST, which coincidentally, was the time of the Fed interest rate announcement, the INDU began to falter. Over the next 45 minutes, the average tanked over 160 points to an intra-day low of 10,635.94. However, like the COMPX, the INDU rallied in the last hour of trading to close up 26.54 points, or 0.25 percent, to 10,707.60.

Helping the Methuselah issues along was retailing behemoth Wal-Mart (WMT), which rose $2.13 to $49.00, posting its third- straight gain. The Bentonville, AK retailer posted earnings of $0.31 per share, matching the First Call estimate.

Hindering the INDU, and much of the banking sector for that matter, was J.P. Morgan (JPM), which fell $4.94 to $150.63. The blue-blooded banker and many of its brethren were pressured most of the day on Fed interest rate concerns. Additionally, the group had to contend with credit quality worries that emerged late Tuesday when First Union (FTU) revealed that it expected an increase in non-performing loans due to one large syndicated credit exposure totaling $500 million. The credit is thought to be extended to beleaguered appliance maker Sunbeam Corp. (SOC). First Union lost $0.63 to close at $26.25 after tanking $4.00 yesterday.

On a more positive note, today's bronze-star award goes to Analog Devices (ADI), which soared $7.75, or 14 percent, to $63.25 after it topped analysts' quarterly earnings and revenue estimates. Analog posted earnings of $0.54 per share compared to the $0.50 per share expected by First Call. What's more, the company posted revenue of $806 million compared with estimates of $800 million. For the next quarter, Analog expects earnings from $0.58 to $0.60 a share, topping estimates of $0.54. So why no gold star, you ask? Analog was trading at $103 two-and-a-half months ago.

After last week's routing of both old and new alike, I suppose we should be grateful for this week's reprieve, but I'm not. In fact, I'm more than a little miffed at our Federal Reserve. Practically all of the major economic releases over the past few months have pointed to a slowing economy. To that end, the economic release du jour showed that industrial production fell 0.1 percent in October. The market expectation was a 0.1 percent increase. Over the past three months, industrial production is up at an annual pace of over 3 percent, which is in line with expectations of a slowing but still growing economy.

Contrary to popular Fed belief, inflation is not an issue. If you need more proof, just look to those folks who making a living trading Treasurys for a living.

The yield on a Treasury instrument is basically comprised of the real interest rate and an inflation premium. The real interest rate is generally a static number -- it doesn't fluctuate much. What does fluctuate, though, is the inflation premium. Look at the chart of the 10-year Treasury note and you'll notice that the yields are shrinking, which means the inflation premium is shrinking, which in turn, means traders don't perceive inflation as a risk. In fact, they consider it even less of a risk when they bid down the premium.

As for the rest of us who trade in equities, I'm beginning to turn downright optimistic on this market. As hard as this may be to believe, I actually want this joke in Florida to continue ad infinitim, for the longer it goes on, the more Americans will realize how little government matters in their daily lives. In fact, I think the market is already starting to get the point. Yesterday, the COMPX rallied nearly 200 points and would have rallied at least another 60 today had the Fed done the right thing. You might think I'm crazy, but I wouldn't be surprised if the COMPX breaks through resistance of 3,200 tomorrow.

As for the INDU, I think it might be in a better position for an advance than the COMPX. The INDU broke out of its downtrend yesterday and now trades above its 200-dma of 10,689, which hopefully will provide support from here forward. On the topside, look for mild resistance at 10,800, followed by 11,000.

Keep the faith. I realize we've all been looking for a rally starting the first of November. In fact, I think we would be in the midst of a rally right now had Florida's government not screwed up the election as badly as it did. Unfortunately, this winter rally will have to start a month in arrears.