There’s an old adage on Wall Street, “three steps and a stumble”. The Fed has been rather savvy about its timing of statements and market moves. Fed officials will be out in force this week to reassure the public, politicians, and investors that the latest move to raise the discount rate was only intended to back away from the extreme reaction to the financial crisis and was not intended to be the start of a new policy toward tightening. This is “step 1”. It is always step 1 to back away from excessive easing and not a step toward tightening. However, just to make sure that the Fed’s intentions are clear, Bernanke will be on the Hill Wednesday and Thursday to reassure everyone that the Fed intends to remain accommodative until the economy is in full recovery and jobs are on the mend. However, the first step has been taken! The next one won’t be as well received. Even though the Fed funds rate is still at zero to 25 basis points, any move on either Fed funds or the discount rate will be seen as an effort to start the “exit strategy”, which has all sorts of implications in-and-of itself. Despite the Fed’s attempt at reassuring investors that rates will not be headed higher soon, it is clear that the next step is toward a tightening, and that will be in the back of everyone’s mind.

Monday kicked off with a merger, but it was not well received. Schlumberger SLB (-3.7%) announced plans to acquire Smith International SII (+8.8%) for $11 billion in stock. Schlumberger is a major component in several of the oil indices, which provided a negative drag on the sector indices. The combination of the two companies will produce the world’s largest oilfield services company. The NYSE Natural Gas Index XNG fell 1.6%. When a company uses its own stock rather than cash to buy a competitor, it is sometimes construed as indicating that the acquiring company believes its stock is fully valued, and it is better off using stock, rather than cash, to buy other assets. This may have been part of the thinking that put pressure on the Energy sector. However, it probably had as much to do with the general outlook on the economy. Investors were digesting the Fed’s action and it does raise the question as to whether or not a discount rate increase might adversely impact a very tenuous recovery at this stage. We’ve seen very solid manufacturing and factory data, and expect that trend to continue throughout the first quarter data, but many believe that the strength is due in large part to the government stimulus. The Obama Administration is looking for more funding, but the partisan bickering is at a fever pitch. It is uncertain as to whether or not more stimulus can pass, and that could result in an economic slowdown. Given the uncertainty and the Fed raising rates, the Schlumberger merger deal did not have the “coattails” for which one might have hoped under normal circumstances.

Energy had been one of the market leaders in this bounce off of the recent low. Losing that leadership raised concerns that the bounce might be running out of steam. Combating this fear stemmed specifically from the strength in the Financials. There were several reasons for the banks to move higher. Dow component Bank of America BAC (+2.1%) rallied after a federal judge “reluctantly” approved a $150 million settlement between the bank and the Securities & Exchange Commission. The suit was filed over Bank of America’s disclosures prior to the acquisition of Merrill Lynch. This ends the uncertainty over exposure for B of A. Regional banks also pressed higher after Sanford Bernstein raised its rating on PNC Financial PNC (+2.8%) to an “outperform” from “market perform”. The Congressional Oversight Panel reported that banks were working to restructure commercial real estate loans, as they face $200 to $300 billion in losses. Despite the fact that a restructured loan could still default in the future, by making concessions and having them “restructured”, banks do not have to include them as “non-performing”. This frees up capital for other investments. The plan, or should we say “hope”, is that the economy improves and holders of these commercial loans will be able to lease property and start making payments. It’s a delay tactic, but spreading out the pain over several years could help avoid seeing the “other shoe” drop suddenly. To that end, the Financials provided the market with enough strength to keep the bears at bay, but investors are clearly a bit nervous after four days of consecutive gains.

Technically, the averages did well to move above the key resistance points. Those levels, Dow 10,270, S & P 1104, and NASDAQ 2200, were the start of overhead supply. There isn’t a “substantial” top, but enough to call it technical resistance. This week is rather light on the news side. Later in the week, President Obama will host his summit on healthcare reform. The Republicans were ready with the DOA stamp before the proposal hit the table. It really doesn’t matter how much Obama strives for a bipartisan bill. This is a mid-term election year and any words are fighting words. Besides, this is a lay-up for Republicans. It really doesn’t matter what the bill says. The Republican’s are willing to run with a strategy to “stop the tax-and-spend policies of the Democrats” as their campaign slogan. Meanwhile, the added attention to healthcare reform is detracting from what Main Street really wants to talk about… jobs. The other major talking point for the week will be Fed Chairman Bernanke. Starting Wednesday, he’ll be telling Congress why raising the discount rate was not a “tightening” and why the economy will recover. Wall Street is cautious at best, and these hearings have become pre-election fodder for Senators and Congressmen bent on blame and insults. Don’t expect anything positive to come from these two meetings. Any misstep and investors will start whispering the word “test”.