What a Week: Clouds Part

Comforting words from the Fed and a healthy dose of M&A help the market shake off recent woes.
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The stock market's climb this week suggests that investors may be seeing the clouds part after a three-week-long bout of volatility.

Some unwinding of the yen carry trade has not caused a massive liquidity crisis, and China's stock market is back up to new highs. And though the flailing subprime mortgage industry continued to be in the spotlight, traders were comforted when the

Federal Open Market Committee

carefully threaded the needle in its statement Wednesday, allowing it room to cut rates but remaining vigilant on inflation.

"The fear was that the Fed, which has seen core price inflation move from 2.6% to 2.7% in the eight months since it stopped raising rates, would abandon its data-dependent, vigilant stance on inflation just because the stock market fell 4% to 5%," says James Bianco, president of Bianco Research.

Instead, the Fed managed to loosen its tightening bias without abandoning it, which is just what the markets wanted.

"The market rallied because the Fed didn't screw up," says Bianco.

While investors dissected the Fed's missive, housing data were weak but not disastrous.

Motorola

(MOT)

,

Halliburton

(HAL) - Get Report

and

FedEx

(FDX) - Get Report

offered up discouraging profit warnings or at least uncertainty about the economic future, but the bad news was balanced by a heavy dose of merger-and-acquisition activity.

And near the week's end, private equity firm Blackstone Group filed for an initial public offering, suggesting that one of the world's premier shops for valuing companies was satisfied with a near $40 billion valuation for its own operation. Some worry that what looks like an "exit strategy" for Blackstone means a top for the market, but the filing itself didn't do any harm.

The

Dow Jones Industrial Average

gained 3.1% on the week, putting it back into the green for the year. The Dow is now up 0.1%, or 17 points, year to date.

The

S&P 500

added 3.5% over the five days, marking its best week in four years. The

Nasdaq Composite

also surged 3.5% this week.

"In a decidedly positive reversal, each of 10 sectors and all 64 industries within the S&P 1500 posted positive gains this past week," writes Brian Belski, U.S. sector strategist at Merrill Lynch. The top three performing sectors, according to Belski, were energy, telecommunications and utilities.

Energy stocks outperformed in conjunction with an 8.9% jump in oil prices on the week. Shares of the

Oil Services HOLDRs

(OIH) - Get Report

exchange-traded fund jumped 5.7% on the week, while

Exxon Mobil

(XOM) - Get Report

and

Chevron

(CVX) - Get Report

added 7.4% and 8.4%, respectively.

Other economically sensitive parts of the market also outperformed. The Dow Jones Transportation Average gained 2.9% this week, while the Morgan Stanley Cyclical Index advanced 3.2%.

The strongest day in the stock market came Wednesday at Bernanke's now-practiced beckoning. Instead of saying that "additional firming" will depend on incoming data, the Fed said that "future policy adjustments" will depend on incoming information.

Traders at first interpreted the more neutral tone to mean that rate cuts were coming down the pike. The fed funds futures market immediately priced in a 40% chance of a rate cut in June, up from 24% before the statement, though the odds reversed later in the week to pre-FOMC statement levels.

But for August, that market now marks 85% odds of a rate cut, up from 65% prior to the release of the Fed's statement.

The yield curve, which has been inverted for months between two-year Treasury notes and 10-year and 30-year bonds, finally normalized after the FOMC statement. It ended the week flatter, as the yield on the two-year and 10-year notes both ended at 4.61%. The 30-year bond yielded 4.80% on Friday.

The Fed's words did draw out some bond market vigilantes worried about inflation to drive up yields on the 10- and 30-year bonds.

But, bond traders were also following the stock market's lead, says Bianco, as Treasury traders started to believe in a stronger economy. According to Bianco, the 10-year Treasury yield has a 70.8% correlation to the S&P 500. So, in the S&P's best week in four years, the bond market took notice.

"The S&P 500 is the most important economic indicator right now," says Bianco. "It implies a tailwind for the economy."

It's not clear where the tailwind will come from, as most acknowledge the housing slump is likely to take several quarters to work itself out. This week's housing reports were mediocre. Housing starts were higher in February, but that rise followed the weakest January in nine years. Existing-home sales were higher than expected, but prices declined and inventories increased.

Next week is flush with more economic signals, as February's durable-goods orders, new-home sales and personal income and spending data will stream in. Likewise, Bernanke will testify before the Joint Economic Committee on the subprime mortgage market on Wednesday.

With a bigger docket of data and Fed-speak, we'll learn if this week's really closed the book on an early spring correction, or if there's more drama ahead.

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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