Friday, May 20, 2005

Market Week in Review

S&P 500 1,189.28 +3.05%*

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BOTTOM LINE: Overall, last week's market performance was positive. The advance/decline rose, every sector gained and volume was average on the week. Small-caps, Cyclicals and Tech shares outperformed as investors began anticipating a slowing in the Fed's pace of rate hikes. Measures of investor anxiety were lower on the week. The AAII % Bulls is still at relatively low levels, but is no longer registering extreme investor pessimism. Mortgage rates are now only 50 basis points away from all-time lows set in June 2003. The downward move in energy prices continued and the contango in the futures market still exists. I believe this situation, slowing demand, excess supply and a firmer US dollar, will result in a much larger decline in oil prices than most expect. An accelerated decline will likely occur when the contango begins to reverse itself. The Fed has likely been targeting the CRB Index, which has been the main source of inflation fears. The recent breakdown in the CRB is unambiguously positive for future inflation readings. Low long-term interest rates and falling gold prices correspond with this view. Fed comments will likely remain relatively hawkish until closer to the June meeting, thus keeping downward pressure on commodity prices. I continue to believe the Fed will hike rates at the June meeting and remove the "measured" language, paving the way for a pause in their rate of hikes. It appears as though the recent rally has legs. All my intermediate-term trading indicators are bullish for the first time since September of last year. As I have been saying for several months, lower inflation, low interest rates, modest growth, reasonable valuations, lower energy prices and a relatively healthy labor market should help to propel stocks further in the second half of the year.

*5-day % Change

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