What a Week: Three-Act Drama

"One of the scenarios that could happen [in 2007] is that the markets will have a 'the sun will come out tomorrow' theme running all year -- always expecting the Fed to cut, but not at this meeting," says Ethan Harris, chief economist at Lehman Brothers. "They could continue to forecast that for a long time. There is a bias in the market to expect a more dovish Fed than reality."

A more dovish Fed means lower rates, which is the key to many strategists' forecasts for stocks. "Our bullish case for 2007 rests on the idea that the yield curve has to normalize," says Barry Hyman, equity market strategist with EKN Financial. Without bringing down the funds rate and normalizing the yield curve, the spread between short- and long-term Treasury yields, expectations will ratchet down for higher multiples for growth stocks, says Hyman.

"The growth story depends on the Fed being cooperative," he says.

Stocks finished the first, shortened week of the year on a down note. Interest rate and Fed expectations were in play, as were worries about the commodities selloff that accelerated this week. While low oil prices are good for the inflation picture, large drops in copper and gold make investors concerned about the global economy. That said, other liquidity-sensitive asset classes such as junk bonds and emerging-market debt did not see risk premiums rise, a typical reaction to economic concerns.

Open Those Windows

Investors this week unloaded some of last year's best-performing stocks, in a classic undoing of window-dressing, notes Brian Belski, U.S. sector strategist at Merrill Lynch. Investors may have chased the strong stocks of 2006 when the rally persisted through last fall, but they are letting them go this year in favor of "growthier" parts of the market such as technology, biotech and consumer discretionary stocks.

Telecom, energy and materials stocks, last year's three strongest sectors, posted the worst performance this week, writes Belski. "Every energy name in the S&P 1500 posted negative returns for the week," he writes.

Oil rebounded about 1% Friday, closing at $56.31, but remains down 7.8% on the week. Exxon Mobil(XOM Quote) and BP(BP Quote) slipped 4.5% and 3.2%, respectively, in a week that also included a warning from Nabors Industries (NBR Quote) and cautious comments from ConocoPhillips (COP Quote).

Shares of metals miners Phelps Dodge(PD Quote) and Freeport McMoRan(FCX Quote) fell 2.6% and 7.9%, respectively, on the week.

Biotechnology companies fared well as several companies were upgraded in the week. Shares of Amgen(AMGN Quote), and Genzyme(GENZ Quote), rose 4.7% and 7% on the week, respectively.

In sum, as the markets began the new year, many bullish forecasts hinged on a first-half rate cut. So signs of economic strength are now met with consternation, as was certainly the case with Friday's jobs report. As the year unfolds, it could just be the adjustment and acceptance that the Fed is not cutting rates soon that spurs a much-anticipated correction.

1 What would best describe your stance heading into the coming week of trading? Bullish Bearish Neutral 2 Which of these sectors do you think is set to move up in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities 3 Which of these sectors do you think is set to move down in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities View the results without voting