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Newsletter April 29, 2006 Do You Have A Detailed Action Trading Plan? Market & Sector Review Expectations Largest Changes This Week This Week's Economic Reports Do You Have A Detailed Action Trading Plan? Anything we do well we do from a subconscious level without thought. Driving a car is an excellent example of subconscious operation. When we need to stop or accelerate quickly change lanes or make a quick turn we don't think about it we just do it. It wasn't always that way. When we first learned how to drive we deliberately thought out and planned every move. At first you needed to consciously and deliberately perform each action over and over. Over time and with practice you learn to perform each task with more skill and eventually with hardly any thinking at all. This learning process is true in most facets of life. We learn through repetition or practice. Despite intuitively understanding this many new traders think they can trade on the spur of the moment instead of carefully planning a trade and following a detailed trading plan. Detailed trading plans are an essential ingredient for success. Lacking the necessary experience a novice trader may find it difficult to trade on the spur of the moment. With too many issues to attend to you are bound to make mistakes. Dr. Peter Gollwitzer, Professor of Psychology at New York University, has conducted several studies that demonstrate the benefits of making specific plans that outline when, where, and how to perform an action. If you have not previously done so it will be a great exercise to write the following as part of your plan: If market condition A happens; And stock condition B happens; And chart pattern C appears; Then I should enter: (A partial position? A whole position?) At the market or put buy stop Z into affect. Then I will set my protective stop and monitor this trade until an exit occurs. Elaborate as desired and/or needed! Knowing when, where, and how helps you perform effortlessly and gracefully. Specific plans help us respond quickly and automatically when it is necessary. When we make a plan beforehand, we can follow it, acting swiftly and efficiently. What does research on making plans reveal? During studies on making specific action plans, Dr. Gollwitzer argues "plans allow people to more easily remember what to do specifically. They don't waste time trying to recall what it is they are going to do. They have decided what to do, and when, beforehand and have little trouble doing what they had planned. Secondly, research "people respond quickly when they have a plan to follow. Thirdly, when people have a plan, they can effortlessly ignore interruptions and distractions. They are able to more easily focus on the task at hand, maintaining self-control." If you have a clearly defined plan you will be ready to respond efficiently when the proper and optimal conditions arise. We respond not only swiftly but confidently when we have a plan. If you want to trade like a winner make a detailed trading plan and follow it! Market & Sector Review Expectations You've probably heard about the markets' discounting function, which is to say the market has a tendency to look six to nine months out, discount what in its infinite wisdom it sees, and trade accordingly. That is not to say that the market is always correct in what it sees for the future in fact I have often heard, as I am sure you have, that the market has correctly discounted six of the last three recessions. Nevertheless the market will attempt to trend with what it sees as emerging trends in the future and not off what is currently known. This week let's take a look at what I think the market is looking at and what might go wrong with that outlook. Since the beginning of 2006 it appears the bulls had been counting on the following: good earnings reports and the end of interest rate increases by the Federal Reserve. With few exceptions earnings reports have certainly been stellar. I for one am wondering how many companies are being overly conservative in their guidance with the sole purpose in mind to surprise investors during earnings season. This is leading many to believe the economy has not slowed very much if at all and in fact may be gaining strength. Friday's GDP report can only add to this thesis of gaining strength being the strongest in two and a half years. Now that earnings season is mostly behind us lets move on to the Federal Reserve and interest rates. Tuesday April 18, 2006 the Federal Reserve released the minutes to their March 27-28 meeting. Headlines by the news services conjured up thoughts that the Fed is just about finished raising interest rates. Of course after the Fed is finished raising rates they will surely begin to lower them again, making stocks even more attractive against alternative investments. A high volume advance ensued as the market began to look six to nine months out at lower interest rates. It was the headlines not the reading of the minutes. You can review the minutes of that meeting yourself here: Fed Minutes. Everyone appears to be more interested in headlines than reading and thinking. When I reviewed those minutes I had a great deal of difficulty understanding just what inspired the headlines of the day. "The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with increasing the federal funds rate to an average of around 4¾ percent." The vote encompassed approval of the paragraph below for inclusion in the statement to be released shortly after the meeting: "The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives." In addition the following statements were included in the minutes: Labor demand continued to increase in the first two months of 2006, as private nonfarm payroll employment showed large gains in both January and February… Consumer spending appeared to have rebounded strongly in the first quarter… Housing activity had moderated somewhat from the robust pace of the past summer. Although the level of single-family housing starts was unusually high in January and February, much of this strength was likely the result of mild winter weather; new permit issuance extended the downward trajectory that began in October… House price appreciation appeared to have slowed from the rapid pace of the summer, but price increases for both new and existing homes remained well within the elevated range that has prevailed in recent years. Readings on core consumer price inflation were favorable in recent months… Nonetheless, the overall consumer price index edged up in February after registering a large increase in January that was driven mostly by a spike in energy prices… Higher energy prices still seemed to be passing through to the prices of a number of core intermediate materials, although such increases were more moderate than those observed in the immediate aftermath of the hurricanes last autumn. If we go back in time a bit to 2002 the Fed began lowering interest rates as well as making money readily available in order to fight what was then thought to be imminent deflation. Deflation was successfully, at least for now, defeated. The result however was a boom in real estate and real estate refinancing. It is widely believed that the real estate refinancing along with the increase in values led many to cash out part of their new found equity and put that money into the economy; fostering much of the economic growth. The fed then proceeded to raise interest rates in order to cool off that real estate bubble, however money is still plentiful. Housing activity and prices have not only moderated but prices (depending upon where you live) have certainly declined. In addition refinancing activity has cooled dramatically. Therefore to varying degrees the Fed has at least partially accomplished the initial objective. I don't believe they wish to send real estate prices into a tailspin. We can therefore argue that the Fed will at least pause in their raising of rates after the May meeting. The obvious question is what happens next? The futures markets (Fed Funds) are currently discounting a ¼% rise to 5% at the next Fed meeting; it's probably written in stone. However if we look out at the distant months and into 2007 trading is still around 5%, in other words the futures markets currently believe the Fed will stop at 5%. The obvious question; should the Fed begin a pause in raising rates, when will they begin to lower rates again? Perhaps the question should be will they begin to lower rates at all soon after the pause? I believe that will greatly depend upon what happens with the inflation numbers and of course the economy. The following chart is from the Federal Reserve Bank of Cleveland: The important point in the above chart; for most of the past 16 years the consumer price index rose between 2% and 4% with a few spikes both up and down. For the first time beginning in late 2001 - 2002 an uptrend began to form, outlined on the chart by the orange trend lines. Perhaps not so coincidentally, this is when gold bottomed and began its to date, spectacular rise. If we take out the spike due to hurricane Katrina the consumer price index remains in the subdued range of the last 16 years. I believe the Fed will be looking closely at is this number before deciding to lower rates or begin another round of increases. The Fed hates inflation and I believe will start anew increasing rates if the above trend continues to develop, even if they have to cause a recession. If after a brief pause the Fed begins to raise rates, stocks will be in trouble, you need look no further than the stock market during the last inflationary time period the 1970's. Most appear to be focused on the energy markets; believing that once energy prices begin to slide the stock market will be free to make its next substantial advance. While this certainly makes logical sense the charts do not support that hypothesis. Rising oil prices have led to rising stock prices although oil is a bit more volatile. Could it be with the internal deterioration I have noted in past newsletters that the energy sector is mostly responsible for the advances in the averages? This newsletter is looking out a bit into the future and should not influence your trading in the near term. The internal deterioration or distribution appears to be continuing, I do not believe however, it is yet enough to cause the major averages to roll over at this time. In the past two weeks the Investors Intelligence survey showed a decline of 8% in the number of bulls to 45% and an increase in bearish sentiment to 26%. This, almost alone, leaves me in the bullish camp near term but stock selection is of utmost importance in the current environment. Be sure to take the time this weekend to check out your favorite sectors (rankings and composite charts) and stocks for their current condition. Largest Changes This Week This Week's Economic Reports Have A Great Week! Bill Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.