Notes on the First 9 Trading Days of 2007

We’re 9 trading days into 2007 and I thought I’d comment on some of the things I’m seeing in the market.

(1) Changing Perceptions About the Fed – When the Fed minutes were released on the year’s first trading day, Wednesday January 3, they caused a dramatic reversal in the stock market.  The stock market went from being up big to being down big.  The S&P went from a high of 1429 all the way down to 1409 before rallying towards the end of the day. 

Why?  Because the Fed suggested that while growth was slowing, inflation was still a concern as well.  This raised the possibility that the Fed wouldn’t be able to bail out the economy by lowering rates.  So, the feeling that the Fed would lower rates to boost the economy in the first part of this year lost sway and the market fell. 

However, the market seems also to have come to believe that the economy is holding up stronger than it might previously have thought and that, therefore, we might not even need a Fed cut.  That’s why it’s held up as well as it has.

(2) Falling Oil Prices – Oil has fallen from around $60 a barrel to today’s close just above $51.  This is as low as oil has been in a long, long time – it hasn’t been below $50 since May 2005. 

Cheap oil means decreased costs for businesses and for consumers (gasoline).  This is thought to help businesses make more money and consumers spend more.

Falling oil last week led to a nice rally from around 1415 to 1430 in the S&P 500 on Thursday and Friday.  Commenting on the rally Robert Harrington, head of US stock trading at UBS’s US brokerage arm, said (subscription required): “Oil was the real driver.  Lower energy prices are like a tax cut for the consumer.”

(3) The “Soft Landing” Hypothesis Still Reigns – Most investors continue to believe that the fall-out from housing will be mostly contained within that sector and will not cause a recession.  Growth will slow in 2007, goes this way of thinking, but not so much as to put us in a recession.  Therefore, stocks remain a good investment.

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Based primarily on (3), the fact that the soft landing hypothesis continues to hold sway, I expect the market to continue to trend upward in the near term. 

As I’ve written many times, I don’t hold this view.  I expect housing to have a huge impact on employment and consumer spending and to put us into a recession, even if the GDP is still nominally growing because inflation is so high.  But this won’t get priced into the market until more and more people begin to believe this which will depend on how and when the data comes out. 

So, for the near term, I think it’s good to ride the market’s bullishness while keeping a close eye on any signs that sentiment is beginning to turn. 

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Earnings Season Gets Underway – After the close today, Intel (NASDAQ: INTC) reported a somewhat disappointing quarter.  Revenues were down about 5% and net income 39% from the year ago period.  The stock is getting hit in after hours trading.

How earnings come through will heavily influence which way the market goes in the first part of this year.  Thomson Financial and Reuters (subscription required) tally analysts expectations at higher than 9% growth.  If that turns out to be correct, the soft landing hypothesis will be intact and strengthened and stocks should rally nicely in the first part of the year.  That is my expectation.

Should earnings be surprisingly weak, however, the soft landing hypothesis could crumble and stocks start to head down.