The market simply cannot find its bottom. Again, financials are leading the way down. All three major indexes dropped by more than 2% for the week. It appears that the Fed is losing credibility among some investors after the surprising auction news announced less than 24 hours after the Fed meeting. But in retrospect, the Fed is right on at least one thing – inflation. Following yesterday’s surprisingly high PPI number, today’s CPI number also surprised the market on the up side. More important, the core CPI number was also higher than expected, indicating that higher energy price and food price may indeed have spread into other areas. Although one month’s data didn’t represent a trend, it did increase the chance of a word that many economists feared so much back in the 1970s, that is, stagflation. For now, the market is expecting a 80% chance of 25bps cut at the Fed’s next meeting, down sharply from just two days ago.
Treasury bonds dropped following the inflation news while the US dollar got another boost with diminishing chance of further rate cuts. This in turn caused many commodity prices to tumble for the second day in a row. Next Friday will bring us the last quadruple witching option expiry day of 2007 so some extra volatility should be expected. In addition, we are also going to get the first of a series Fed special auctions on Monday and several brokerages are also set to report their earnings throughout the week, including Goldman on Tuesday, Morgan on Wednesday and Bear on Thursday. It is indeed going to be another busy week. Stay tuned!

Volatility is the name of the game these days. As if yesterday's more than 300-point reversal in Dow was not enough, the market had another triple-digit reversal today and closed the day again relatively flat. Being the first major brokerage firm reporting its quarterly results, Lehman Brothers provided the market with a mixed report. On the earning's front, the company appeared to beat the estimation. However, its fixed income sector saw a huge 60% drop in revenue compared to one year ago, indicating tough market conditions in the future. In addition, the company indicated it may need to further write down its mortgage backed assets. Not surprisingly, the financial sector continued to slide after the open and several firms even challenged their November lows. But by the end of the trading session, most financial companies were well off their lows and appeared to have experienced a "capitulation" day. I would like to emphasize here it's until we see stabilization in the financial sector before we can see the general market to stablize, so it's worth paying special attention to the sector. Although several major indices managed to close the day in green, the internal of the market was decisively negative as evidenced by almost 2 to 1 decline/advance ratio in NYSE.
The economic news is also mixed this morning. On the positive side, we got a much stronger retail report for November. This surprising report will greatly boost Q4 GDP number and indicate less chance of an imminent recession. On the other hand, the PPI number also surprised the market and renewed fears about inflation, which may handicap the Fed from cutting interest rate. The surprisingly high PPI number also gave a boost to US dollar, which in turn caused many commodity prices to tumble. Both gold and oil closed the day down by roughly 2%. Treasury bonds continued to sell off as some asset rebalancing appears to be ongoing before year end. Finally we got some good news on the LIBOR. The rate that banks charge each other dropped accross the yield curve and if the trend can continue, it may really mean something.

What a roller-toaster day on Wall Street! Dow was up by more than 270 points in the first 15 minutes following the open and was down by more than 110 points during the last 15 minutes before closed the day basically flat. The US Fed surprised the world this morning by announcing that five central banks led by the Fed would move in concert to supply liquidity through auctions. Although the Fed officials immediately denied that the news had anything to do with the criticism following yesterday’s interest rate decision, the timing was a little suspicious. Wall Street, however, didn’t buy the idea that injecting liquidity into the financial system would alleviate the credit crisis as the financial sector was quickly turning into negative territory after the market open. Although apparently investors are bearish on the outlook of the financial sector, I think it is equally important (if not more) to remember that it is usually not a wise choice to fight against the Fed. Things will become much clear when the Fed holds its first such auction on Dec 17th.  Oil price was up by more than 4% and now is back above $93. For the year, it is up by 54%. Tomorrow we are going to get the earning report from Lehman Brother and the market will certainly pay attention to how the brokerage has fared during the tough quarter ending in November.

Wall Street was certainly disappointed by the latest Fed decision on interest rates. Not only didn’t the Fed cut its key discount rate by 50bps as many market participants had hoped for, it failed to show the urgency of the credit market tightness in its statement. Basically it means the Fed is going to wait for worse financial and economic condition before making the next cut. All interest rate sensitive sectors were sold off sharply following the news. Although I don’t think they are going to re-test the November lows in the short term, they are also going to have difficulty moving much higher from here.  Not surprisingly, the treasury bonds rallied sharply while the spreads between risky bonds and risk free ones were increasing. The US dollar also rallied against most major currencies except for the Yen, which got strengthened as investors avoided risky assets by unwinding yen carry trades. Since we are very close to year end, trading activities may not follow the usual pattern due to year-end window dressing.

It seems the Santa Claus rally is around the corner. Despite the sub-prime mess, the credit crunch, and the potential slow down in the economy, Christmas is still Christmas. However, investors do have a big test tomorrow – the last Fed meeting of 2007. Right now the market is expecting 25bps cut in the Fed fund rate and 50bps cut in the discount rate. In addition, the market is looking for the Fed indicating in its statement that there will be further rate cuts coming. Do investors ask too much? Not really. The fourth quarter GDP is currently on track to be flat, down sharply from the previous quarter’s almost 5% growth. The job market is expected to slow further entering into 2008 and the probability of a recession is still quite high despite joint effects by the Treasury Department and the Fed to avoid such a scenario. But for now, I guess if the market wants to save those worries for 2008, why shouldn’t we?