Waiting to Retest the Lows

02/19/2008 12:00 am EST

Focus: MARKETS

Bryan Perry

Editor, Cash Machine, Premium Income, Quick Income Trader, Instant Income Trader

Bryan Perry, editor of The 25% Cash Machine, says the market may retest its lows as investors’ fears counteract the additional stimulus provided by the Fed’s rate cuts.

The most recent economic data clearly show a further slowing of economic activity as 2008 gets under way. There is declining gross domestic product (GDP) and employment growth issues that have raised the caution flag even higher—and all of that is setting the stage for the Federal Reserve to drop rates further in mid-February, if the data continue to show deterioration.

The market senses this, which explains much of the ebullient behavior of the equity markets, and why we may see any retest of the lows well-contained and constructive. The Dow Jones Industrial Average rallied 1,100 points in the span of eight trading sessions, putting in what technicians call a “V” bottom formation—but it’s a pattern that is not so desirable.

What chartists want to see is something they call a “double-bottom, higher-low” formation. That’s when the major averages spike off the reaction low (as they did), but then sell back down to test the lows never touching them, and then reverse back higher and form the “W,” which supports the argument that a genuine bottom is in place.

There is great wisdom in the old Wall Street adage, “Don’t fight the Fed.” Assuming the “W” pattern occurs, we will see the market do some constructive filling and then resume its upward bias as anticipation of near-term Fed cuts takes hold of investor sentiment. Lower interest rates reduce the cost of money and restore confidence—and those are the two most important things this market needs.

We’ll watch the financial sector closely to see if it can hold on to its recent gains. I continue to read a lot of negative commentary about further write-downs, and the spread of the default crisis to the credit-card industry and other lines of debt.

The market really wants to believe the worst is behind it. I do, too, but there are still way too many unknowns about the housing and credit markets—particularly whether they will respond to the big shots of stimulus.

These past few weeks, I’ve gravitated toward more conservative income strategies, not knowing just how much the economy might slow. I’ve trusted that past is prologue, and that the power of lower rates will prevail supported by a Congress and White House that will eventually come to their senses about out-of-control spending. But then again, I’ve hoped this hope before, and it is an election year.

The negative, near-term outlook for the economy is being addressed by the Fed, but banks in the United States and abroad are rapidly tightening credit lending. This will make refinancing much more difficult (even when mortgage rates adjust lower) as banks require higher credit scores and more equity to do deals. This tightening of lending standards will put the brakes on further discretionary spending.

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