What a Week: Constant Change

Ben Bernanke sparked his third massive rally in about a month, but the midweek revelry soured Thursday and Friday amid uncertainty about the economy, corporate profits and geopolitics.

While investors now believe the Fed is likely to take a breather in August, the future of the economy is not so clear. The incoming data has been a mixture depicting a strong labor market, exports and business spending, but a weaker housing market, lower retail sales, high energy prices and higher inflation. The Wall Street Journal's front page editors took nine weeks to go from putting the rise of the "Goldilocks" economy on page one, to last weekend's front page exploration of a possible recession in the U.S.

The market has gone the distance too, as a bond rally, inverted yield curve, failure to rally on bullish earnings and excessive bearish sentiment suggest investors don't believe the Fed's forecast for a soft landing.

The fed funds futures market this week reveals investors' relentless uncertainty. At the end of last week, the odds of an 18th fed funds rate hike in August were dipping due to the political uncertainty around the world. But those odds rose to 74% by the end of Tuesday as investors prepared for Wednesday's CPI report and Bernanke's congressional testimony. When the core CPI, excluding energy and food prices, rose 0.3% for the fourth consecutive month, the likelihood of an Aug. 8 hike jumped to 90%, only to decline an hour later when the Fed released Bernanke's testimony.

By the end of Wednesday, the odds fell to 65% and dropped to 54% Thursday after the June 29 FOMC minutes showed some committee members weren't convinced that meeting's rate hike was needed. Odds of an August hike now stand at 34%, according to Miller Tabak.

The futures markets no longer predict any further tightening beyond 5.5% through the balance of the year. Odds of a rate cut in the first quarter of 2007 have started to show up as well.

The markets lost their barometer for rate moves since the Fed dropped the phrase "measured pace" from its statements in January. Combined with Bernanke's rookie mistakes, investors can't be sure of any bets, says Kevin Cronin, head of investments at Putnam Investments. "The market is wrestling with a heightened level of uncertainty."

Reflecting that uncertainty, the stunning mid-week 'Bernanke rally' was wiped out and major averages ended the week near last Friday's levels. The Nasdaq Composite stood out, as the tech-heavy index plunged to new lows for the year once again. The Nasdaq finished Friday down 0.9%, and lost 0.83% on the week to close at 2020.39. The Nasdaq has now fallen 5.13% over the past two weeks, and is down 8.4% on the year.

The Dow Jones Industrial Average fell 0.5% Friday and finished the week off 1.2% to close at 10,868.38. The S&P 500 slipped 0.63% Friday, but closed the week up 0.33% at 1240.29.

The Dow Jones Transportation Average declined 0.8% Friday, after dropping over 4% Thursday, reflecting the market's concern about the economic slowdown. Brokerage stocks also declined, with the Amex Securities Broker/Dealer Index falling 1.31% Friday and 1% on Thursday. The 10-year Treasury bond rallied through the end of the week, to yield 5.04% at the end of the day Friday. The dollar gained amid the geopolitical turmoil through the beginning of the week, but weakened after Bernanke's testimony and expectations for a pause in rate hikes.

"Positioning portfolios today for a definitive end to the monetary policy tightening cycle may prove premature," writes Jane Caron, chief economic strategist at Dwight Asset Management, which has $60 billion in assets under management. "We advise keeping some powder dry (cash) in the event that a Fed pause proves to be temporary."

The FOMC minutes provided perhaps the biggest spark of uncertainty, as they reflected dissension among the FOMC members. In one paragraph, the minutes present a discussion of the market's reaction and expectations for Fed policy -- an atypical inclusion, says Putnam's Cronin. "Are they the FOMC leading monetary policy, or following the markets?" he wonders.

The Fed chairman seemed to lead stocks higher Wednesday, the market's third day since June 15 with 10 times as much upside volume as downside, according to Don Hays, president of Hays Advisory Group. "This has occurred only three other times in the last 44 years," writes Hays. "In each of those three times, at least a 10% return occurred over the next six months by the S&P 500."

If the markets are in for such strong returns, they are not likely to occur in the near term. If nothing else, the Bernanke uncertainty factor has caused investors to be more risk averse. To wit, TrimTabs Investment Research estimates that equity funds that invest in U.S. stocks saw $4 billion of outflows in the week ended Wednesday, compared with $1.2 billion in the previous week.

If uncertainty over the Fed wasn't enough, earnings were peppered with unpleasant surprises, particularly in the tech sector. Dell ( DELL) sliced its second-quarter profit forecast, citing aggressive pricing and a slowing commercial market. The computer maker's shares fell 9.91% in trading. Indeed, lower earnings guidance or earnings misses from the likes of Intel ( INTC), Yahoo! ( YHOO), eBay ( EBAY) and Qualcomm ( QCOM), pressured the market this week.

Despite overall strength in earnings thus far this quarter, it seems to take more than a home run to spark any excitement in the underlying stocks. Caterpillar ( CAT), for example, fell 1.1% Friday despite reporting strong second-quarter results.

According to Thomson Financial, 66% of the 152 companies in the S&P 500 that have reported earnings thus far beat estimates, while 20% matched and 14% have come in below expectations. The forecasters still predict 13.6% earnings growth this quarter. "It would take a drastic change in the numbers for us to drop below double-digits at this point," says John Butters, analyst at Thomson.

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 here to send her an email.

More from Opinion

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook