The Fed Can't Fight the Market's Fight After Tuesday's Meeting
By David A. Gaffen
Staff Reporter
5/14/01 6:16 PM ET
As much as the market would like, the Federal Reserve isn't going to cut interest rates forever.
Alan Greenspan & Co. may indicate that Tuesday marks the final cut, or they may hint that they'll throw the market one more cookie. Either way, the Fed -- which has occupied the markets' attention since it first started cutting on Jan. 3 -- is about to be eclipsed on Wall Street by the profit picture and the outlook for a second-half recovery. For a significant rally to take place through the end of the year, the market is on its own.
"The market now has to take a show-me attitude" toward earnings, said Joe Keating, chief market strategist at Fifth Third Bank in Grand Rapids, Mich. "We're finally at the point where the market is accepting that sufficient stimulus is in place, and now, let's see how quickly it begins to work."
I Want a New Drug
Barring some kind of total meltdown in the economy, the Fed probably will finish cutting rates with the fed funds rate around 3.5%, give or take a few basis points, after starting the year at 6.5%. The four rate cuts this year -- especially the two surprise ones -- were positive catalysts in January and April.
The old adage of not "fighting the Fed" is true. But, as January's rally demonstrates, if the only thing you've got going for you is the Fed, it may not be a fair fight. The market surged as the Fed kicked off its rate cuts, but the rally withered as people realized most companies were still drowning.
What will happen, then, to April's rally? The Fed's actions are a positive benefit for companies, but it won't make specific companies more profitable if they don't execute. The market needs a new drug now.
In the next few months, the economy must recover. Corporate earnings are always important, but lousy earnings for the next two quarters are already being assumed. What's more important is how chief executives characterize their particular businesses and their estimation of demand -- and that the economy itself continues to perform well.
That's no different from the fourth quarter and the first quarter, or any time, really. What's different this time is that then, the market fell back on the Fed, begging it to respond to market woes. Now, that avenue is more or less closed to the market. Friday's session, which ended with the market down significantly following stronger-than-expected economic reports, is disappointing in a sense. It shows some investors are still concerned about a smaller-than-expected rate cut.
But with the Fed already having acted aggressively, there's less room to cut rates, and with growth at 2% and the consumer continuing to spend, there's little reason to expect it will ultimately drop the fed funds rate any lower than 3.5% in coming months.
Not Going to Zero
Which is why the market could be tripped up if statements from companies indicate little improvement in business spending and profitability. Concerns that profits may not recover at the end of the year and in 2001 would supersede the perceived benefit of ongoing consumer spending and increased money funneled into the financial system as a result of rate cuts.
In such an environment, investors could be looking at months of fragmentation in the stock market. Some sectors of the economy base their primary decisions on lending rates and consumer demand, while others have different factors, such as production constraints and acceptance of new technology.
The Fed can't target these factors individually. If the labor market holds together and consumers aren't spending, the Fed isn't going to cut rates to 0% just because technology, or some other sector, isn't improving. More likely is a period of sluggish growth for some, but outperformance by a number of sectors that benefit from the increased money in the system.
"The market is going to have trouble, not so much with the Fed, but with earnings and valuation," says Charlie Crane, market strategist at Spears Benzak Salomon & Farrell. "The valuation scenario right now is not particularly attractive. Investors have to be real company-specific in this environment."
The hodgepodge of names hitting new highs on the New York Stock Exchange are an indication of the current market's state; it's unclear what investors want to bet heavily on when stocks as varied as UnumProvident (UNM:NYSE - news), Caterpillar (CAT:NYSE - news) and Jones Apparel (JNY:NYSE - news) are at their peaks.
There were a lot of winners in April after the market bottomed out. There are going to be winners and losers in the next several months. The Fed won't be able to do much about it.
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