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Yields Continue Higher Despite Massive Purchases By The Fed

By Dave Moenning: the chief portfolio strategist for the ETF Channel Flexible Growth Investment Portfolio.

Tuesday's session definitely didn't end well for the bullishly inclined. One minute the screens were green and there was talk of Santa Claus arriving early. But then the next minute the Dow was red, which, while a Christmas color, did not present a festive scene.

While the explanation for the late-day dive was fairly easy to identify (think boys and their toys), the current market environment seems to present more than a few contradictions in terms that traders are going to have to sort through as we enter into the New Year. But before we get to the big-picture stuff, we would be remiss if we didn't address the reason the bears went home happy yesterday. In short, a big sale of the e-mini's and a headline involving the insider trading investigation came together (a coincidence perhaps?) in order to create a made-to-order sell program environment. And before you could say, "Hey, isn't that old news?" the bears were off and running.

Although I do see the current environment as positive and I do think stocks will likely work their way higher in the coming months, this does not mean that there aren't some things that need to be resolved. For at first blush, there seems to be an awful lot of contradictory issues right now.

Let's start with interest rates. While everyone is very excited that the FOMC is going to be buying up nearly $1 trillion in bonds over the next six months or so in order to keep interest rates down, it is worth noting that the exact opposite is occurring as yields. I doubt I'm the only one that has noticed that the yield on the 10-year has gone from 2.48% in early November to 3.17% at yesterday's close.

Then there is the dollar. As we've discussed at length over the past few months, "the trade" has been to short the greenback and go long those "risk assets" (stocks, commodities, and emerging markets). QE2 was supposed to further this trade as rates were supposed to stay low and the extensive borrowing planned by the government was expected to keep the dollar low. But, in keeping with this morning's theme, the dollar hasn't exactly been cooperating fully. And if the economy improves, well, I'm just saying...

Next let's look at the much ballyhooed "deal" to extend the Bush-era tax cuts. This was initially thought to be good for stocks as it removes uncertainty. In addition, it removes the possibility of the administration repeating one of the errors of the 1930's by raising taxes during a critical point in the economic recovery. However, some traders argue that the extension of the tax cuts will be a bad thing as it will mean higher deficits and lower tax revenue - and remember, if your outflow exceeds your intake then your upkeep will be your downfall.

Then of course, there is the political aspect of the compromise. While the open-minded might see the compromise as a good thing for the country and perhaps even for politics in general, the President is taking it on the chin from both sides and everybody seems to be unhappy about something. Thus, we appear to be back to the mindless political bickering.

Finally, there is the topic of the austerity movement in Europe, which, may or may not find its way to our shores at some point. The good news is that Italy announced an impressive deficit cutting plan on Tuesday. This will help the country fight off the bond vigilantes and perhaps help thwart further contagion. The bad news is that lower spending will lead to slower economic growth, lower revenues, and if not done properly, civil unrest.

So, while there are certainly some good things happening out there, we do find it interesting that a lot of those "good things" can also be a bit contradictory at the present time.

Turning to this morning... Things are fairly quiet in the early going. Concerns over European debt continue as there was a lack of any EU quantitative action today. Also on the debt front, both Fitch and Moody's commented on the potential deterioration of the U.S. fiscal position given the extension of the tax cuts without any offsetting measures. Bond yields are rising, commodities are under pressure, and stock futures are pointing down ever so slightly at the present time.

Finally, don’t forget, ego is the real enemy in this game...

Wall Street Research Summary

Upgrades: * Vivus (NASDAQ:VVUS) - BofA/Merrill * Dole Food (NYSE:DOLE) - BB&T Capital * Chiquita Brands (NYSE:CQB) - BB&T Capital * Intersil (NASDAQ:ISIL) - Canaccord Genuity * Oceaneering Intl (NYSE:OII) - Credit Suisse * Foster Wheeler (NASDAQ:FWLT) - Goldman Sachs * KBR (NYSE:KBR) - Goldman Sachs * Nationwide Health (NHP) - Jefferies * AGCO (NYSE:AGCO) - Target increased at Jefferies * Ecolab (NYSE:ECL) - JPMorgan * Avid Technology (NASDAQ:AVID) - JPMorgan * Bio-Rad Laboratories (NYSE:BIO) - Leerink Swann * Dominion (NYSE:D) - Morgan Stanley * Texas Instruments (NASDAQ:TXN) - Target and estimates increased at Oppenheimer * Salesforce.com (NYSE:CRM) - Tarter increased at RBC Capital * Red Hat (NYSE:RHT) - RBC Capital

Downgrades: * Arch Coal (NYSE:ACI) - Citi * Alpha Natural Resources (NYSE:ANR) - Citi * Patriot Coal (PCI) - Citi * Johnson Controls (NYSE:JCI) - Deutsche Bank * 3M (NYSE:MMM) - Goldman Sachs * Netflix (NASDAQ:NFLX) - Jefferies * Entergy (NYSE:ETR) - Morgan Stanley * Varian Medical (NYSE:VAR) - Piper Jaffray * Capella Education (NASDAQ:CPLA) - RBC Capital * Micron (NASDAQ:MU) - Estimates reduced at UBS * Weyerhaeuser (NYSE:WY) - UBS

Long positions in stocks mentioned: ISIL, RHT

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