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Bulls Hack Out of a Thicket

Economic data provide little clarity, but shares creep higher despite Greenspan's subprime warning.

Thursday brought a mix of economic signs -- some strong little crocuses sprouting after spring's first defrost. But, there are some suprime weeds growing in this garden, and its future is uncertain.

Not only are there big down days in the stock market, like Tuesday's, intermixed with smaller up days like Wednesday's and Thursday's, but there are no clear or lasting sector rotations. The rallies and the selloffs are broad-based. Volatility remains unleashed, but sentiment is no longer at extremes. And the major indices fluctuate back and forth over the neutral line throughout single trading days as they did Thursday.

On the macroeconomic front, with subprime-spillover concerns battling for attention with higher inflation readings like Thursday's producer price index, traders admit they're not sure where the spinning top will fall.

That's especially true on a day like Thursday, when the private-equity bidding wars continued, copper broke out, and cyclically sensitive parts of the market gained ground. Indeed, the markets ran counter to the soft manufacturing that the weak regional Philly Fed and New York Empire State surveys belie.


Dow Jones Industrial Average

gained 0.2% Thursday to close at 12,159.68, while the

S&P 500

finished up 0.4% to close at 1392.28. The

Nasdaq Composite

ended the day up 0.3 to close at 2378.70.

"People really don't know exactly what is going on in the economy," says Randy Diamond, trader at Miller Tabak. Thursday's lower report of initial jobless claims for the week fuels the bulls who say all is well as long as the job market remains intact, he says. But "people are also seeing the stickiness in inflation," he says.

The more closely watched consumer price index comes out Friday morning, but traders are expecting a steep reading because of Thursday's producer price index results. The core PPI rose 0.4% in February vs. expectations for a 0.2% reading and after last month's 0.2% rise.

Headline producer prices rose 1.3% against analysts' expectations for a 0.5% increase. The jump in headline inflation was due mostly to higher energy and food prices, and traders believe the same will be true for consumer prices.

"A benign CPI reading could ease people's fears," says Diamond.

Indeed, the

Federal Reserve

, which has left the fed funds rate unchanged at 5.25% since last August, is oddly facing a bit of a deja vu situation. Last spring, the markets sold off amid fears of a liquidity crisis while inflation crept up and the Fed got closer to pausing. Sounds familiar, but this time around, the Fed may be getting closer to cutting rates, and there is more at stake in playing that hand.

"Traders are aware the Fed has nothing up its sleeves," says Diamond.

Pausing doesn't inject liquidity into the market, while cutting rates does. If the Fed cuts rates to "rescue" a downward spiral in the residential real estate market (something former Fed chief Alan Greenspan warned of Thursday), the results could lead to much bigger problems and even higher rates in 2008, says John Lonski, chief economist at Moody's Investors Service.

As Diamond says, "it is like feeding an addict."

In a rising-inflation environment with a robust job market, more liquidity in the form of a rate cut could make inflation not just sticky, but virulent.

Indeed, it is still hard to argue that the 17 consecutive fed funds-rate hikes that brought the overnight borrowing rate to 5.25% have done much to curb risk appetite or to tighten lending standards anywhere but the housing market.

Housing-related stocks got a reprieve Thursday as

Bear Stearns


became the latest broker to downplay its exposure to subprime and say it sees opportunity amid the recent carnage. Those comments helped push shares of

Accredited Home Lenders

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Novastar Financial


sharply higher, while homebuilders rallied despite some downbeat comments from

Toll Brothers

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CEO Robert Toll, who called the spring selling season "a bust,"



Meanwhile, banks that pulled the financing plug on subprime lending institutions have just replaced the high-yielding borrower with other suckers ... err, clientele. Bank credit facilities to high-yield, or speculative-grade, companies hit a record high in February and are on track to better the record by the end of March, says Lonski.

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In concert, high-yield bond spreads, or risk premiums have only modestly widened in the market's recent turmoil. The average junk bond's risk premium, about 320 basis points over comparable Treasury bonds, is wider than recent lows around 250 basis points. But the 320 average remains well under the average risk premium in the best parts of recent economic expansions, says Lonski. Risk premiums in the most recent 1993-97 credit-cycle upturn averaged 387 basis points.

The stock market's favorite markers of robust growth were back on the field Thursday, too.

In merger and acquisition activity,


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agreed to by



for $3.2 billion, or a 23% premium. Cisco slipped a fraction while WebEx jumped 22%.

Blackstone squashed rumors that the firm would launch a competing bid for Texas utility



but reportedly said it would join with current equity partners Kohlberg Kravis Roberts and Texas Pacific Group if they needed another equity partner on the $32 billion deal. TXU gained 0.7% on the day, even as regulators started to make noise about the potential deal.

Dow Chemical

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gained 5.6% on news the company plans a joint venture with an India-based petrochemical company.



added 2.7% ahead of the company shareholder vote Friday on whether to accept a $26.5 billion buyout bid from


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or to wait on a higher bid from

Express Scripts


, which gained 1.6% Thursday.

When copper breaks out, most traders roar, "strong economy." Today was no different. The price of an ounce of copper surged 5.7% to $2.99 -- breaking above its 200-day moving average. Copper miners

Freeport McMoran Copper & Gold

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Southern Copper


, and

Rio Tinto


l gained 6.7%, 2.8% and 2.9%, respectively.

Oil fell 1% Thursday, to $57.55 per barrel -- weakness that suggests the typically slower spring and summer seasons may be kicking in. The lower oil price spurred a 0.9% rally in the Dow Jones Transportation Average.

This is hardly the stuff of a major economic crisis. Then again, the million-dollar question is whether the subprime problem could overtake the economy given the right climate. With that still unanswered, the market is likely to remain skittish. And, if subprime problems spread, the Fed, like any gardener, would have to chop the heads off a few flowers to kill the weed.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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