January 22, 2008
 

Fed Cuts Rates

Despite the Federal Reserve's decision to cut the Fed Funds Rate by 75 basis points to 3.5 percent, stocks dropped in early trading on Tuesday.

In the absence of new compelling economic data, this unscheduled aggressive rate cut could be perceived as targeting asset prices, which the Fed has been reluctant to do. However, the Fed likely made the move in an effort to have the greatest possible impact before its scheduled meeting next week.

Futures on the S&P 500 Index had fallen 4.5 percent before Tuesday's opening (before the Fed's decision was announced).

Overseas stocks plunged while U.S. markets were closed in observance of Martin Luther King Day, as fears of an economic downturn intensified. In both Asia and Europe, prices slid as much as seven percent and as much as six percent in Latin America.

Commodity prices also moved sharply lower, including metals, grains, and energy. Both the dollar and the yen strengthened. Each of these moves betrays an indiscriminate flight from risk.

Whatever merit there was in the theory of decoupling (by which foreign economies and their stock markets would be well-insulated from a U.S. downturn) is being sorely tested.

Coming into this week's trading, the broad averages in the U.S. were already down 15 percent from their October peaks. A sell-off of the magnitude suggested by declines in the futures market would push us to the brink of a bear market. A number of overseas markets are already there, as are small cap stocks domestically.

So far, at least, investors are not waiting around to see if this might represent a buying opportunity. While it is probably no time to be a hero, one missing ingredient in trying to identify a buying opportunity in this three month decline has been a selling climax, where investors throw in the towel because they can no longer endure the pain. We have come close, but until now have not yet pierced the support above truly oversold conditions. We may be getting close.

The Week Ahead

Unfortunately, this week's economic calendar is devoid of any meaningful scheduled reports (with the possible exception of existing home sales). As a result, there will be nothing to blunt the growing concern regarding a possible recession.

Conversely, the earnings calendar is full, including scheduled reports from seven components from the Dow Jones Industrials Average. Aside from the Fed, earnings represent the market's best chance for some good news this week, but the numbers have to be strong and the guidance upbeat, and the latter has been in rather short supply.

The Next Week

The following week contains a barrage of important economic reports, including among other fourth quarter GDP, January employment, the December personal consumption deflator, the national Institute of Supply Management report, as well as the Federal Open Market Committee meeting.

Also scheduled for Monday is the President's State of the Union address in which George W. Bush is expected to call for the swift passage of an economic stimulus package totaling approximately one percent of GDP.

Whether this happens remains to be seen. It is an election year and everyone in Washington wants to be seen as concerned and responsive to the American consumer. But the political mating dance required to agree on a package will be delicate. Neither party wants to give the other an election year boost. As a result, agreeing on a stimulus program may be more difficult than it appears.

As we have recently commented, volatility is a fact of investing life. It is part of the price of entry. Market corrections occur every two years on average, and bear markets occur every 5.75 years. For long-term investors, downside moves in equity prices create value that can translate into rewarding gains as markets recover. It is important not to let emotion obstruct participation when a recovery begins.