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With markets overbought and in the control of hedge funds and trading desks, bad news could easily spook bulls. For months the government and most Wall Street pundits have been pounding the table to focus our attention on the various "core rates" (excluding food and energy) when viewing inflation data. That worked well for the "inflation is contained" crowd because "core" CPI and PPI rates backed their sanguine views. But things changed today as a sharp drop in energy led to a tame "headline rate," but higher auto prices pushed the core rate surprisingly higher. (Gee, and I thought auto sales were lower which would argue for lower prices right? Well, maybe just for U.S. manufacturers.) With investors content and markets overbought the surprise in the numbers led to profit-taking.

With the PPI rising unexpectedly you might think gold would also rise with it as inflation expectations increase. Not in the Alice-in-Wonderland world of Wall Street where investors think the Fed will remain on "pause," which would be negative for gold, as higher interest rates hurt gold.

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So, if Producer Prices were uncomfortably high why were bonds unchanged today? It seems that overseas buying of treasury securities remains strong ($116B in August vs. $32B in July), offsetting concerns about higher rates. (The mutual-understanding continues -- U.S. consumers buy overseas goods and exporters recycle dollars by buying U.S. bonds.)

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Homebuilder's were cheered today as the National Association of Homebuilders released data showing that confidence within the industry grew from 30% to 31%. Let's not get carried away shall we? The index was at 68% a year ago. In the release, David Seiders, chief economist for the homebuilders, stated: "The increase in October suggests that builder attitudes for new-home sales may be stabilizing." (Emphasis added since I hate that hackneyed real estate term.)

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Now I know we've beaten to death the megabanks' trading influence on markets, but you should analyze Merrill Lynch & Co. Inc.'s (MER) earnings results. Excluding the recent Blackrock acquisition, "trading profits" increased 83% to $1.68B, which was the best area of earnings performance. Program trading is (if you believe the new calculation methods from the NYSE) running at roughly 30% of all NYSE volume. The Fed has injected over $65B in liquidity to its "primary dealer" network recently which includes Merrill Lynch & Co. Inc. (MER), Lehman Brothers Holdings Inc. (LEH), Bear Stearns Companies Inc. (BSC) and Goldman Sachs Group Inc. (GS), among others. All of these firms own sophisticated computer trading software and have reported spectacular earnings using your money! ("RoboTrader" at work.) Given this new dynamic maybe we should just admit we love Big Brother and buy streetTRACKS KBW Capital Markets (KCE). KCE major holdings are listed in the following table:

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After the bell tonight many tech companies were reporting earnings with Intel Corp. (INTC), Yahoo! Inc. (YHOO) and International Business Machines Corp. (IBM) up in the after hours, while Motorola Inc. (MOT) dropped nearly 9% on disappointing revenues.

There really isn't much to add since the sell-off today was mild and met with decent buying at the lows. Earnings are more important right now, and we'll just have to wait to see how they turn out. Tomorrow the markets should react to tonight's tech earnings numbers with more clarity than often occurs in after-hours trading. Did I mention options expiration coming on Friday. That should create a little more volatility perhaps.

Disclaimer: The ETF Digest maintains positions in iShares Lehman 7-10 Yr Treasury Bond ETF (IEF) and streetTRACKS Gold Trust ETF (GLD).

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Source: David Fry's Daily Market Outlook