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Seeking Alpha

Tuesday, November 20, 2007

Morning Report: Ominous Volatility & the Fed Catalyst


Down 300 points; up 200 points! Where's it all leading to, you must be asking. We drag into mid-August, rise into mid-October, drop again now... You must be confused. However, there is clear and powerful driver behind each move, the Fed. Market expectations of Fed bias have driven each of these moves, and are behind the currently confused, though clearly negatively biased market direction.

When we were rising, expectations were for a Fed expansionary trend, and as we declined the market was looking for possible restrictive monetary policy to combat inflation. The current environment is one in which the Fed has told us it has shifted to neutral. However, the market still contains many skeptics who argue the Fed is just misinterpreting data and will come to its senses. Today will offer some serious directional data, as the Fed publishes its October FOMC Policy Meeting minutes and begins its new offering of long-term forecasts.

Volatility is clearly increasing, and periods of high volatility have coincided with significant market corrections of the past. We find this ominous and threatening if the right catalyst comes to the fore in the near-term. We are very confident Iran will not be that catalyst now. Our government is not going to start a messy war during the critical fourth quarter. No, you can expect Iran to show up on CNN sometime after January, but likely before June.

Catalysts we cannot foresee include terrorism. Despite the annual shopping mall threat, and intensified chatter heading into the fall, we simply cannot invest or disinvest based on fear of terrorism. The only imminent threat is the Fed and the economy. If data or the Fed issue a wake up call to investors, we will be faced with that crescendo sell-off. So Greek, is it going to happen?

I expect the market has already awoken somewhat, but a further wake up call is likely. I expect that after the holiday shopping season concludes, unemployment will increase significantly as margin squeezed retailers face the reality that the consumer is just not spending like she use to. Higher unemployment, slowing GDP could overcome the Fed and welcome recession surprisingly faster than expected possible by the group. In any event, I believe the Fed will have to cut when it receives the call from the Administration next spring that war has begun. Before then, data will dictate the day and confusion and volatility will rule stocks. Volatility is here to stay for awhile. The CBOE Volatility Index (Chicago Options: ^VIX) has increased 61% from its October 9 recent low through November 19.

In the meantime, kitchen sink write-offs typical of the fourth quarter will continue to offer bad news, and tax loss selling will continue to drive stocks lower, until that fuel is dry. At that point, I believe you can expect a Santa Claus rally sometime in December.

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