Inflation Fighters

On Wednesday the Federal Reserve's Open Market Committee decided at one of its periodic policy meetings to do nothing. This was not a great surprise to anyone, and the stock market reacted with a giant yawn. Bond traders were a little more interested; Treasury prices fell when the Fed statement suggested the committee still regards inflation as the top threat to the economy. This means, for those not fluent in Fedspeak, that interest rates are more likely to go up than down.

At its last meeting on March 21st, the FOMC simultaneously confused everyone and set off a massive rally when it removed the "additional firming" from its statement. Chairman Ben Bernanke was forced to backtrack a few days later by vowing that the Fed really is serious about taming inflation. This week's meeting reinforces the view that the March statement was all a big misunderstanding. Rates are probably not going lower anytime soon.

We like to watch the 20-day moving average as a short-term market trend indicator. Prior to today, none of the large-cap indexes - Dow, S&P 500, and Nasdaq Composite - had closed below their 20-day averages since March 20th. Not coincidentally, this was the day before the Fed's ill-worded statement. Since then the benchmarks have moved steadily upward. Today's pullback threatens to end this short-term uptrend; the Nasdaq Composite closed slightly below its 20-day average and the S&P 500 is very close. Longer-term indicators remain solidly bullish, so at this point we see no need to change our positive outlook for stocks. Nonetheless, the road may get bumpy over the next week or two.

In sector action, utilities continue to lose relative strength while materials are picking up a second wind. The action in materials has a lot to do with a wave of merger activity and rumors of more to come. Falling oil prices have taken some of the froth from the energy sector and also gave a lift to the transports. Telecom and wireless are joining health care in the up-and-coming sector category.