In an unprecedented move, the Federal Reserve made a decision to slash key lending rates to almost zero and “employ all available tools to promote sustainable economic growth and help relieve strains in the financial system.”
The Federal Open Market Committee (FOMC) was expected to cut rates by 0.50% but instead decided on a more drastic policy and cut by 0.75% to 1.00%, targeting the federal funds rate to zero to 0.25%.
The change in policy was treated as a positive by the stock market, which rallied for a better than 5% gain on the S&P 500 (SPX). But more than one observer was startled by the news and Josh Shapiro, chief economist from MFR Inc., said that the “Fed is petrified about the economic outlook.”
The Fed cited data that “indicate deteriorating labor conditions and declining consumer spending, business investment, and industrial production, and the outlook for economic activity has weakened further” as reasons for the unusual decision.
One immediate result of the Fed move was a sharp drop in the price of the dollar. Against the euro, the dollar fell to $1.3792 compared to $1.4097 just before the announcement.
The rally in stocks was broader-based but on relatively light volume and could be accounted for by short covering. But all of the Dow’s (DJI) 30 stocks were up with the biggest gains in the financials. Citigroup (C) gained 11.2%, JPMorgan Chase (JPM) rose 13%, and Bank of America (BAC) improved by 7.02%.
At the close, the Dow Jones Industrial Average (DJI) gained 360 points, closing at 8,924. The S&P 500 (SPX) gained 45 points at 913 and the Nasdaq (NASD) was up 82 points to close at 1,590.
The New York Stock Exchange traded 1.5 billion shares, with advancers ahead of decliners by 6-to-1. The Nasdaq traded more than 902 million shares with advancers there ahead by 4-to-1.
Crude il (January contract) fell to $43.60 a barrel, off 91 cents, and the Amex Energy SPDR (XLE) rose $1.49 to $49.49.
The February gold contract closed higher by $6.20 to $842.70 per troy ounce, and the PHLX Gold/Silver Index (XAU) closed at $120.83, up $8.21.
What the Markets Are Saying
The initial response of investors to major news is not always the correct response, and Tuesday could be an example of stocks rising for all of the wrong reasons.
Yesterday’s move by the Fed to cut rates to below 1% is not only a major shift in policy, but the unprecedented action of slashing the rates to close to zero should alarm investors. We should be asking why. And the answer is not very encouraging.
In the Fed’s own words, it is because of “deteriorating labor conditions, declining business spending, business investment, and industrial production.” And, “the outlook has weakened further.”
Even if the Fed’s new initiative — which has not been fully explained — is successful, it will take some time to have an impact. And before that, investors will have to face some pretty lousy Q4 earnings and then have to confront more earnings trauma in Q1 of 2009.
But the stock market rallied yesterday and each of the major indices closed above their 50-day moving averages. The Dow (DJI) exceeded its 50-day moving average by 96 points, the S&P 500 (SPX) by 11 points and the Nasdaq by two points.
On Tuesday, I said that a close above the channel formed by the 20-day and 50-day moving averages could indicate the direction of the next market move. But yesterday’s almost irrational response by the market, on relatively light volume, could also turn out to be just one big sucker play drawing in equity buyers for the final kill.
I’ll refrain from jumping on board this rally for now and remain very skeptical unless volume improves, along with our other tested indicators. Shakespeare said that “Something is rotten in the state of Denmark.” And something is rotten in the state of our economy and no amount of the Fed’s perfume can overcome the foul odor.
Today’s Trading Landscape
Earnings to be reported include: Apogee Enterprises (APOG), Commercial Metals Co. (CMC), ConAgra Foods (CAG), CPI Corp (CPY), General Mills (GIS), HEICO (HEI), Joy Global (JOYG), Lindsay Corp. (LNN), Luby’s (LUB), MDS Inc. (MDZ), Morgan Stanley (MS), Nike (NKE), Nordson (NDSN), Paychex (PAYX), Take-Two Interactive Software (TTWO) and Xenonics Holdings (XNN).
The following economic reports are due: MBA Mortgage Application Survey, third-quarter current account balance (the consensus expects a $179 billion deficit), U.S. Energy Dept. oil inventories for Dec. 12 and the API Oil Industry Report for Dec. 12.
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Sam Collins is a registered, fee-based portfolio manager who may be contacted at samailc@cox.net. You can also check out an archive of some of his most recent market outlooks by clicking here.
