What a Week: Market Mopes Around Waiting for Fed Fuel

Bleak earnings news dampens indices while the CPI and PPI power the 50 basis-point-cut hopes.
By Robert Mann ,

SAN FRANCISCO -- Another week in which the stock market did its best to confound expectations came to an appropriate end on Friday. Stocks didn't fare as poorly as was initially feared on Friday, but their midday bounce also proved fleeting. That stocks ended lower at the end of the day was also fitting, given the week's overriding trend of weakness.

For the week, the

Dow Jones Industrial Average

fell 3.2%, the

S&P 500

shed 4% and the

Nasdaq Composite

tumbled 8.4%.

Heading into Friday's session,

JDS Uniphase's

(JDSU)

warning following Thursday's big losses generated concerns the triple-witching session could be scary, indeed. A preopening warning Friday by

Nortel

(NT)

accentuated such fears, as reflected by the decidedly negative tone in futures trading.

But after some steep early declines, major averages bounced sharply and fought to reclaim positive territory before fading into the close. Once as low as 10,566.55, the Dow traded as high as 10,716.30 before closing off 0.6% at 10,623.64.

Other averages produced similar patterns as market participants took some salvation in the latest round of punk economic news. As previewed

Thursday night, the data fueled growing expectations the

Federal Reserve

will lower rates by 50 basis points when it meets later this month.

The fed funds futures contract on Friday was pricing in a near 40% chance of a 50 basis-point ease at the Fed's meeting June 26-27. That compares with pricing in a less than 10% chance at the beginning of the week. On Friday,

Merrill Lynch

chief economist Bruce Steinberg,

Salomon Smith Barney

economist Robert DiClemente and

Tucker Anthony

director of economic research Kathleen Camilli each revised their forecasts to a half-point cut vs. a quarter-point, joining

Lehman Brothers

financial economist Drew Matus, who'd made the same prediction Thursday.

Key among Friday's data was that industrial production fell 0.8% in May, the eighth-straight monthly decline and below forecasts for a 0.4% drop. Capacity utilization fell to 77.4%, the lowest rate since August 1983. Elsewhere, the

University of Michigan's

consumer sentiment index for June dipped to 91.6 vs. 92 in May.

The capper was the

Consumer Price Index

, which rose 0.4% in May -- in line with expectations -- while the core rate rose 0.1%, half the gain expected by economists. The CPI report and Thursday's weaker-than-expected

Producer Price Index

convinced Fed watchers that inflation remains under control, giving central bankers leeway for more aggressive rate cuts.

The

Cleveland Fed

reported Friday its median CPI rose 0.3% in May, bringing its year-over-year increase to 3.5%. Thursday's PPI showed finished goods, excluding energy, have risen at an annual rate of 4.3% this year vs. 1.5% last year (thanks,

Bill Meehan). Also on Friday, the

Philadelphia Fed

released its semiannual

Livingston Survey, which showed economists raising their expectations for CPI inflation this year to 3.3% vs. 2.8% in December.

But the latest economic data have market players "less convinced that the economy will rebound quickly, and thus less concerned about inflation due to the Fed's rate cuts,"

BondTalk.com

commented Friday. "Fed officials have also been actively downplaying

inflation expectations," and the strategy appears to be paying off.

The bond market rallied for much of the week as the slow growth-no inflation sentiment grew. The long end of the bond market retreated Friday, but the yield on the two-year note remained below 4%. Prior to this week, the two-year note hadn't yielded less than 4% since October 1998.

International news this week evoked memories of the global financial crisis of that era -- including Japan's economy contracting in the first quarter, the

European Central Bank

cutting of growth estimates, accompanied by higher-than-expected inflation reports in Germany and the U.K., and the Brazilian real trading at an all-time low.

In currency trading, speculation the ECB might intervene helped the euro trade at its highest level vs. the dollar since May 22. Meanwhile, Japan's yen stumbled 1.8% vs. the dollar and 3.3% against the euro this week,

Bloomberg

reported.

Love It Or Leave It

This week, however, the only international issues garnering the attention of most U.S. investors were those directly effecting U.S. stocks, such as the European regulators' squashing of the proposed

General Electric

(GE) - Get Report

-

Honeywell

(HON) - Get Report

merger.

That aside, investors were (understandably) more focused on domestic events such as the economic data and the latest string of profit warnings. In addition to JDS Uniphase and Nortel, this week's culprits included

Affymetrix

(AFFX)

,

Nokia

(NOK) - Get Report

,

CTS

(CTS) - Get Report

,

STMicroelectronics

(STM) - Get Report

,

International Rectifier

(IRF)

,

Tribune

(TRB)

, and

McDonald's

(MCD) - Get Report

.

The avalanche of warnings raised serious doubts about the second-half recovery scenario, as reflected in the performance of stocks. That, in turn, raised concerns among some market watchers.

On Thursday, James Rohrbach of

Investment Models

announced his Nasdaq model was flashing a sell signal, reversing a buy call on April 18. His

NYSE

model maintains a buy signal.

As reported previously, Rohrbach does not claim to be able to exactly time market tops and bottoms, but aims to identify them quickly enough to catch the bulk of upswings and miss the worst of downswings. The implication of Thursday's call being that he expects more weakness in the Comp.

Conversely, other gurus are taking solace that the rising anxiety among investors means the selling is approaching a climax.

On Thursday, the 10-day average of the

Arms Index

hit 1.412, Don Hays of

Hays Advisory

in Nasvhille, Tenn., noted in a report Friday morning. "A move above 1.30 is an indication that a significant buying opportunity is very close at hand."

Additionally, the equity put/call ratio hit 80.26 Thursday, the highest level since April 3, he noted, while the McClellan oscillators dropped to oversold levels.

"None of these indicators guarantee a bottom was made

Thursday," Hays continued (a point made clear by Friday's action). "But they do tell you that the odds are extremely high that unless the market is setting up for a further cataclysmic decline ... this juncture will prove to be another very significant buying opportunity."

What could spur another trading rally is investors faith in the Fed, as Friday's midday bounce indicated. Although 250 basis points of rate cuts so far this year have seemingly done little to aid the economy, much less stocks, investors continue to take solace in the prospect of additional Fed action.

Another reason to expect a near-term bounce is that Steve Hochberg of

Elliott Wave Financial Forecast

previously identified June 19-21 (plus or minus one day) as the next Fibonacci turn window.

To review, the windows are not designed to predict market direction, but points in time when the market's prevailing direction will subsequently reverse.

Clearly, this week's prevailing market direction was down.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.

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