The major indexes finished mixed again in what turned out to be a rather choppy week of trading. After a downside reversal Monday, equities traded modestly higher over the following three sessions. This came despite a continued rise in the 10-year note yield and elevated commodity prices. However, on Friday, things changed as the equities markets suffered a sharp setback and gave up most of their gains from prior sessions. Expectations of higher rates along the yield curve appeared to be the catalyst for Friday's decline. At the same time, the key averages had become short-term overbought, so a pullback was to be expected at some point.

Up until Friday, the big theme was how resilient equities were in the face of many negative factors. All it took was one decline and suddenly rising rates were back to being a concern. Despite the claims of many, rising rates along the yield curve do matter. It's very simple. Our economy today is extremely leveraged, and therefore is extra sensitive to the direction of interest rates. Thus far, rising rates have not mattered too much. But things are now changing. Real estate sales have plunged on a national basis, while prices are finally starting to decline. Also, many of the prior adjustable rate mortgages are now starting to float. This means sharply higher monthly mortgage payments for consumers, and only a rate cutting cycle by the Fed will save the day. There is a possibility of refinancing in “gimmick” loans such as negative amortization, but banks are becoming much tighter with lending standards in the current environment. Furthermore, the lack of spread between short and long rates makes taking on risk much less profitable for lenders.

With everything above taking place, it's very likely that we could see a consumer retrenchment in the 2nd half of 2006. At this point, a soft landing scenario may still be possible, but further hikes by the Fed significantly increase the chances of a hard landing for both the economy and equities. Consequently, as long as the Fed maintains a bias towards further hikes, it's best to proceed with caution on the long side. Friday's retreat could very well be the start of an overdue correction.

Daily Pivots for 4-10-06

Please feel free to email me with any questions you might have, and have a great trading week!

Chris Curran
chris@tradewindsonline.net

Chris Curran started his trading career at the age of 22 with a national brokerage firm. He combines fundamental and technical analysis to get the big picture on the market. Chris has been trading for 15 years, starting full time in 1997, and has never had a losing year as a full-time trader.