Thursday, January 4, 2007

Markets lift off the new year, stall out

Anxious traders got 2007 off the ground a day later than originally planned due to the death of former president Gerald Ford. The markets were closed on Tuesday, but made up for lost time on Wednesday morning, driving vigorously into the positive in early trade. The Dow reached an intra-day all-time high of 12,630.34, but stocks pulled back through the afternoon, especially after the release of the minutes from the Fed's December meeting. The Dow closed up just over 11 points higher. The Nasdaq was up a nominal amount, while the S&P 500 and NYSE Composite finished slightly lower.

The minutes revealed that certain members of the FOMC were concerned that the economy was still expanding at a pace that might induce inflation and traders saw this as a sign that the Fed may still be pondering rate increases.

This kind of reverse-engineered thinking normally occurs when the markets - and the economy - are at pivot points and questioning future direction. If stronger growth is actually on the horizon, that should be good for stocks, but the consensus opinion seems to think that rate increases would be a worse outcome, so it's back to head-scratching and crystal ball gazing.

The biggest news of the day and the stories that really moved stocks early were the forced resignation of Home Depot (HD) CEO Robert Nardelli and a sizable drop in the price of crude oil, which fell below $60/bbl. to end the day at $58.32.

While Nardelli will retire with a handsome severance package worth more than $210 million, the price of oil may not have such a rosy future. Despite repeated and continuing efforts to convince the public that crude supplies are extremely tight, production cuts by OPEC (1.2 million barrels per day announced in November and another 500,000 cut planned for February) and the warm winter in the US Northeast are pushing prices closer to 3-year lows.

With more than they usually need to consider, investors are facing a slow-growth economy (retail for December was not as good as expected), lower oil prices and a Fed concerned with inflation. Two of those three are good, and it can be argued that a cooling off period for the economy is not only welcome but overdue.

The real issue is valuation, which is at somewhat ridiculous levels for entire classes of stocks. Corporate profits have been exceptional during the long bull market and it would be foolish for investors not to take some of their gains off the table soon in hopes of getting back in later in the year.

From the looks of things, being out of this market in the first half of the year may be the wisest investment decision of all.

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