The beginning of the week: correction or rally?

In my opinion, there is a lingering sense of unreality over the stock market in US, too much growth and too little substance.

CNBC and Kudlow were quick to trumpet the DOW 12,000 as a triumph of Republicans and a solid proof of the "soft landing". It's better to err on the cautious side, in my opinion. I'd say time to reap the profits or go short on the index and here are the blurbs from the blogosphere:

Bill Cara with a cautious stance:

"..Double-digit
gain takes Dow over 12,100, Mon., Oct. 23, 2006, 1:55
PM
October 23, 2006Double-digit gain takes Dow over 12,100, Mon., Oct. 23, 2006, 1:55 PM
There is a widening credibility gap between a U.S. Administration that points to a Bull market as evidence that all is well in the American economy and the many confused capital market traders who can’t understand why prices are so high and going higher.
I’ll bet there isn’t a single major broker-dealer in America whose research from a month ago indicates that the DJIA would be above 12,100, heading north. And all the ones I read, which are the biggest firms, all foretold a lower $USD and a higher precious metals price.
Is this a conspiracy to suck retail traders into taking greater risk, or is it truly the case where Wall Street is as confused as the rest of us?
I don’t believe there is a conspiracy here, but I do think the market has been pushed off the rails..."

However the strategy of writing puts on the stocks which would hold on to the rally could be risky and perhaps a more frequent portfolio rebalancing would be needed.

Economics reports with a nice overview over the last week and tendencies which I put here:

Looking Ahead: Week of October 23 to October 27



Wednesday

Existing home sales fell 0.5 percent in August to an annualized 6.30 million rate from 6.33 million in July. Sales have been declining from a record high of 7.27 million in June 2005. Sales are now down 12.6 percent from a year ago. Last week's rise in housing starts but decline in permits have muddied the water somewhat in terms of whether housing has bottomed out or not. While the sales figure is important, the inventory numbers are going to be just as important since housing is not going to bottom until inventories are lean. In August, supplies of existing homes rose to 7.5 months -- the highest in 13 years. There are other signs that housing may be soon firming or at least leveling off. Mortgage rates have been easing in recent weeks and the NAHB housing market index ended eight straight declines, rising to 31 in October from 30 in September. But markets will be closely watching the home sales and inventories numbers to see what they add to the housing picture.



Existing home sales Consensus Forecast for September 06: 6.20 million-unit rate

Range: 6.0 to 6.35 million-unit rate



FOMC statement

The FOMC meets again on October 25. During the last two monetary policy meetings, the Fed left the fed funds interest rate target unchanged at 5-1/4 percent, following 17 consecutive increases. The Fed continues to emphasize that risks are balanced between both inflation that does not decline enough and economic growth that may slow too much. Recently, more FOMC members have emphasized the importance of bringing inflation down and the upside risks on inflation even though markets have discounted any interest rate increases. Markets instead assume that fed funds will remain steady through June 2007. While few expect any interest rate change out of this meeting, markets will be looking to see if there is any change in the policy "bias" in the post-meeting statement. It is almost certain that the Fed will not lower interest rates until the FOMC first removes the inflation concern bias. That is, the Fed will likely announce seeing balanced risks in its statement one meeting before cutting the fed funds rate. Essentially, the first concrete sign for pending lower interest rates from the Fed is an FOMC meeting announcement with the elimination of the inflation bias in the statement. Given recent comments from Fed members, that is not likely to happen this meeting.


Fed funds target rate for October 25, 06: no change at 5-1/4 percent

Range: 5 to 5-1/2 percent



Thursday

Initial jobless claims fell 10,000 in the Oct. 14 week to 299,000, the first sub-300,000 reading in nearly three months. Based on initial claims, the labor market has been firming in recent weeks - a positive for economic growth and good for income growth and support for equities. If initial claims remain moderately low, that will should lead to a rebound in employment growth and take away much of the ammunition for those claiming the soft landing has turned into a hard landing.



Jobless Claims Consensus Forecast for 10/21/06: +305,000

Range: +298,000 to +315,000



Durable goods orders were flat in August after falling 2.8 percent in July. Weakness has been led by aircraft orders. More recently, regional manufacturing surveys and the ISM survey were mixed as the Philadelphia Fed manufacturing survey showed a rebound in October in both current new orders and new orders six months out while the New York Fed's survey reported mild slowing (still positive) in new orders.



New orders for durable goods Consensus Forecast for September 06: +2.2 percent

Range: +0.5 percent to +5.5 percent



New home sales rose 4.1 percent in August to an annualized rate of 1.050 million. Inventory overhang is still a concern even though supply slipped to 6.6 months from 7.0 months in July. As with existing home sales, the markets will be watching both the sales pace and the inventory numbers.



New home sales Consensus Forecast for September 06: 1.050 million-unit rate

Range: 0.900 million to 1.070 million-unit rate



Friday

Second quarter real GDP posted a 2.6 percent increase, following a sharp 5.6 percent jump in the first quarter. The Fed has been indicating that the economy needs to slow somewhat below potential growth before inflation will ease to below 2 percent for the core PCE deflator. Since the Fed has noted that it has lowered its estimates for potential GDP growth, potential GDP now is likely seen to be in the 2-1/2 to 3 percent range. This means the Fed hopes to see GDP growth a little below 2-1/2 percent. The markets do expect below potential growth - at least for the third quarter.



Real GDP Consensus Forecast for advance Q3 06: 2.0 percent annual rate

Range: 1.2 to 2.6 percent annual rate



GDP deflator Consensus Forecast for advance Q3 06: 2.9 percent annual rate

Range: 2.0 to 3.9 percent annual rate



The University of Michigan's Consumer sentiment index jumped to 92.3 in mid-October from 85.4 in September, likely reflecting lower gasoline prices and the continued up trend in the stock market. The markets and the Fed will be watching confidence numbers since that is a factor in the strength of consumer spending and whether we get a soft landing or hard landing. Also, the inflation expectations numbers will get some attention since the Fed is concerned that higher inflation expectations not become embedded. One-year inflation expectations edged down to 2.9 percent in mid-October from 3.1 percent last month and as high as 4.2 percent in August.



Consumer sentiment Consensus Forecast for October 06: 92.4

Range: 89.0 to 93.0

Well, place your bets, gentlemen! Good thing, Fedspeak is becoming more like a science with Bernanke than a voodoo art with his predecessor so post-meeting statement will be easier for the market to decipher.