Market Summary

The end of the first quarter saw the markets consolidate as they give up much of the gains made following the release of the Federal Open Markets Committee statement 10 days ago. That statement invigorated investors as it appeared the Fed was becoming more neutral on its interest rate policy and implied that a rate reduction may be possible later in the year. But Fed Chairman Bernanke took pains to correct that interpretation on Wednesday when he told Congress that the Federal Reserve had not intended to imply that rates may go one way or the other and that inflation risks remain. The markets fell sharply on this re-interpretation of the Fed's position and delivered a fourth distribution day in fourteen days for the NASDAQ. This put the index one distribution day shy of another reversal of our market signal but a slight gain on Thursday and then again on Friday allowed the index to dodge the bullet. By Friday, the Fed Chairman's warning that inflation risks remain was confirmed when the Personal Consumption Expenditure report showed a higher than expected increase to a year-on-year rate of 2.4%, well above the Fed's declared target of below 2%.

In his statement to Congress, Bernanke was optimistic about prospects for the economy and countered the conventional wisdom that we are nearing the end of the business cycle and that contraction was inevitable. On this point too he was supported on Friday with evidence of industrial expansion in the Chicago area and continued strong consumer spending. With inflation increasing and the economy showing more strength than expected, it is difficult to imagine that investor's long hoped for cut in interest rates will materialize.

Other influences on trading this week were a rise in the price of oil to a six-month high and rising international tension. For the week, the DJI slipped 1.02%, the NASDAQ Composite lost 1.11% and the S&P 500 gave up 1.06%. This was also another distribution week for the major indexes, who have not registered an accumulation week since the week ending January 12. This is illustrated for the NASDAQ in the chart below.

Despite this week's consolidation, the rally that began on March 14 continues although we have a pessimistic bias about the outcome of the rally due to weak upside volume and overall distribution. The up-days have not been accompanied by strong volume, which implies investor uncertainty that the rally can continue, whereas volume on down-days has generally been higher. Overall, volumes are below average and all three major indexes met resistance at their 50 day moving average levels. On the plus side, employment remains high, consumer sentiment is still quite strong and the economy refuses to roll over despite the sub-prime lending wipe-out and continued housing market weakness. Many observers believe the housing market will deteriorate further as credit is tightened and fewer borrowers will qualify for loans under tighter lending guidelines. This in itself could cause the Fed to lower rates to bring more borrowers into play and stabilize markets, but the negative effects on an already weakened dollar could cause them to eschew this course, in which case house values will continue to fall until an equilibrium is reached. Bill Gross at PIMCO estimates that house prices will fall 20% if mortgage rates remain unchanged.

As stocks have continued to rally since March 14, more have come into striking range of the pivot points they set before the February 27 collapse and this has resulted in a slight increase in the number of breakouts to 16 this week with an average gain by week's end of 0.8%.

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