The major stock market averages produced another boring week of flat performance, but other markets provided plenty of excitement as the Federal Reserve finally reached the lower bound of ZIRP (zero interest rate policy). The Fed’s two day meeting was widely expected to produce another interest rate cut, but Bernanke surprised the market by going all in and cutting the Fed Funds target to a range of 0-0.25%. The Fed funds market was already trading near that level anyway and for once it seems Bernanke decided to go with the flow rather than fight the market. The statement released by the Fed outlined the quantitative easing measures they are prepared to take over the next few months. Basically what it amounts to is that the Fed will be printing up some new dollars and buying everything in sight. That may or may not get the credit markets functioning again someday, but the effect on the dollar was immediate:

While the dollar rebounded at the end of the week, the recent uptrend has been broken decisively. Whether it continues to weaken from here will depend largely on the actions of the other central banks of the world. It appears we have entered the competitive devaluation phase of this attempt to re-create the Great Depression. While the Chinese are undoubtedly pleased by the actions of the Fed, the Europeans and the Japanese cannot be too happy. The Bank of Japan followed the Fed with its own rate cut down to a paltry 0.1% and Korea cut rates last week. Hong Kong also cut rates.

Japan also announced another stimulus package of 43 trillion yen ($489 billion) half of which will be used to buy equity holdings from their banks. The Japanese are stubborn Keynesians if nothing else. They have enacted a plethora of “stimulus” packages since the early 1990s, all of which failed to stimulate anything other than their national debt. The new Obama administration, faced with this real world evidence, leaked the news that their “stimulus” plan will be in the range of $800 billion over the next two years. Albert Einstein defined insanity as doing the same thing over and over again expecting different results and I think that applies here.

The economic news was again nearly uniformly negative. The consumer price index (CPI) had the largest one month drop since 1932 although core prices (excluding food and energy) were flat. Although this is surely disconcerting to the deflation scaremongers, it is hard for me to summon a sense of foreboding over falling consumer prices. Housing starts and building permits were down again with starts hitting an all time low. The good news is that starts are running about 120,000 less than the annual sales rate so inventories should continue to drop. Jobless claims fell slightly, but are still running very high; the 4 week moving average of new claims is now at 543,750. The Conference Board’s index of leading indicators fell 0.4. Six of the ten indicators were negative but there were four providing positive readings: real money supply, interest rate spreads, new orders for capital goods, and new orders for consumer goods.

Despite the continuing weak economic news, stocks managed to stay basically flat. The DJIA was down 50.57 (0.59%) and the S&P 500 fell 1.04 (0.24%). Those final numbers disguise some of the volatility seen during the week that included a 359 point rally in the wake of the Fed meeting. We were having a nice calm day on Wednesday until S&P decided that wasn’t allowed and announced that the outlook on GE had turned negative. The resilience of the market in the face of bad news would seem to indicate that most of the sellers have left the market, at least temporarily.

I am still optimistic that the rally can carry a bit further to the 1000 level as enthusiasm over the new Obama administration builds to the inauguration. And if this bear market acts like every one in the past, it is likely to get back up to the 200 day moving average at some point. Considering the time it takes to get there, a very optimistic target remains around 1100.

The volatility of the dollar had the expected effect on the gold market. As the dollar fell the first part of the week, gold rallied. As the dollar rebounded, gold fell:

While I am bullish on gold over the long term, it should be noted that gold is not in a bull market yet. This week’s rally failed at the 200 day moving average and until it can get over that level and stay there, this is still a downtrend.

Biotechs and Pharmaceuticals both put in good performances this week.

IBB (Ishares Biotech ETF)

IHE (Ishares Pharma ETF)

 Both of these sectors have lagged over the last few years and the Pharmaceutical sector in particular appears quite cheap.

Next week is light on earnings reports with no major announcements. The economic calendar is fairly crowded though. Tuesday brings the final revision to Q3 GDP, Redbook retail sales, University of Michigan consumer sentiment, new and existing home sales and the Richmond Fed survey. Wednesday sees the release of jobless claims, personal  income and spending, durable goods orders and oil inventories. Friday the Chicago PMI is released.

It’s a short week with the NYSE closing at 1 PM on Wednesday and closed Thursday for Christmas. Trading should be light so any surprises could cause big moves in the markets.

Disclosure: Alhambra and its clients have positions in gold (we own IAU), IBB, IHE and the S&P 500 (we own SPY and IVV).

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