(For October 19, 1998)
<Picture>The Fed Responds to an Unprecedented Credit Emergency !
Coordinated panic among officials. . . .probably stimulated the Federal Reserve Board's very surprising (as far as moment-to-moment trading) twin-moves to cut both the Fed Funds rate and the Discount Rate by a quarter-point each, at approximately 3:20 p.m. ET, during market hours. There's no doubt that most analysts including us, ultimately expected further Fed ease over time. It is reminiscent of 1987, as the Fed steps up to the plate to rescue the markets from a disaster. And yes, if it works, it changes everything going forward for the near, intermediate & longer term.
Also remember that only nominal rates have been cut (wisely kept in reserve); real rates stayed high while the world unraveled. That means Greenspan is really scared now, hopes to halt what threatens to undermine (if it hasn't already) domestic consumer optimism, probably is being now pushed by the New York Fed (the real power) to cut again on November 17, and now we'll see if all these cuts are really bullish, or only temporarily so, as was the case when after the '29 Crash, officials moved from restriction to ease in a frantic effort to sidestep a Credit Crunch. They failed.
If spreads between corporates and governments tighten over the next few days; better look out. Be very careful trading just here; even though a reduction in U.S. rates will likely help emerging markets, while potentially further damaging the Dollar. While the history of Fed moves, of cuts in both of these sectors has always left the market higher 6-9 months later than at the time of such cuts; there is still the risk that this is aimed more internationally than domestically, and in fact will increase dollar-denominated asset repatriation. Tread lightly in assumptions that this market will perform just as it always has in the past; though domestic stimulus (historically) is better received in the United States, than it is overseas. If it does succeed; should markets fear later inflation? Of course the answer is yes, but that's a longer-term factor in topping the T-Bond market next year.
Ironically today's action fundamentally means the Fed agrees; you and I have been very correct about risk of a profits recession in the United States next year, and of how much the Fed risked getting even further behind the curve. While the goose surely came out of the blue; no doubt the rationale behind the Fed's action didn't, and stems from the very factors that put markets at risk. If they pull it off, they will engineer a softer-landing for U.S. companies next year. That's exactly what we mean when (the DB & in the Letter), we've argued that cutting rates doesn't simply just rescue profits (but in fact affirms our view they are and will be in trouble) immediately, but makes the ultimate low not as low as it otherwise would be. In fact just (I think last night) we speculated that can be the difference between an ultimate low a couple thousand points higher than would be the case otherwise. Does that mean the major bottom is behind us? For small-cap stocks, a few of which we've nibbled at already, generally the worst is behind, as already noted. For blue-chips, it doesn't prevent significant testing at minimum or in some cases later new lows. But yes, a chance that those lows will hold higher bottoms is definitely enhanced by Fed trending action.
Will the Dollar get creamed overnight, while the Nikkei soars? If so, a domestic rally may well be a sale; if not, a pullback will be a buy. Prior opinions related to daily trading automatically vanish when the fundamentals change, and that's readily the case today. In fact, historically major lows have been known to occur from nominal washouts and ensuing short-covering (such as into any expiration), upon which a savvy Federal Reserve takes action. Are we fundamentally now into a more bullish bigger picture posture? Too soon to tell; somewhat uncharted territory by the way. (Open-minded; having reversed the short-term attitude a week ago amidst analyst downgrades.)
Before this is over (the next six to nine months). . .you may get to a time when investors will view every further rate-cut as extremely bearish, not bullish, (balance of this section is reserved).
Remember, it is because the Fed has now capitulated to the general non-optimism we've warned of since Spring, that further breaking of the "structural bubble" after this clearly-defined Fed move still has worst-case risk (we won't get into that tonight). At least the Fed is more preoccupied with markets than Monicas, and that's a plus. Just remember; the PE for the S&P still presumes there will not be a recession; and even with the cuts that is still (at least mildly) an odds-on probability.
Market TKO
For the Dow Industrials; let's consider short-term resistance at 8450 or so, with support at 8120. If we can get the former before the latter, we can think of a punch-up to 8700 or so before risk in next year's dicey market hits the market front-and-center. If it works the other way around, then you won't see 8700, but rather a profit-taking wave, a rebound that fails, and then new lows, or at least an effort in that direction. That would (unfortunately) be a TKO for the market, we otherwise define as a "Technical Knockout" (a term we first used I believe, back in the Summer of 1987 before the Crash). Of course, we thought such an event would be a beautiful buying opportunity; now we have an interesting challenge of a market where most smaller stocks have already done that, while many big stocks still trade as if nothing is wrong, or ever will be. This is a different era, as we all know, and that means the outcome of Fed action may not have an unchallenged result.
In Summary. . . there probably are other shoes to drop; we might need to note. And the market has overdone this to the upside, or will have tomorrow, with or without an additional push in the new week. Don't be too skeptical, as we probably get a new rally effort before a decline. Since there are all kinds of rumors out there about unexpired S&P and T-Bond positions that unknown traders hold that could roil (and probably will) Friday's action, an early up-down-up-down-flat call might generally be a reasonable expectation, but likely doesn't do justice to the coming chaos.
The McClellan Oscillator moved from Wednesday's +47 reading to a near-overbought posting of +143, which suggests extreme short-term risk conditions approaching within (reserved) days. Also, today's Summation reading is -1658. S&P premium is 1750 at 7:00 p.m. ET; Dec. futures at 1065, up 100 from Chicago's regular close at 1064. We are flat in our daily trading as of now.
…Thus no change in this general view, or the specific view a week ago that even though overall conditions remain unsettled, not to not press the downside of the market, but play for a rebound, while the Street was increasingly pessimistic. Now, the real question is whether order is restored to the Treasury arena, which recently has experienced uncharacteristic volatility, even though in many ways it was inline both with our forecast for a "panic in" once stocks broke even though the Dollar broke then (as called for), and now is slightly disorderly, though we indicated expectations for it to snapback to "test the highs" before succumbing. (Bond/stock relationship call; reserved.)
Remember, at no time (the last time was 1992) when the Fed cut Funds and Discount rates at the same time, was the PE of the S&P still at illusory and risky price levels. In Japan, when they (years ago) cut rates, you got one heck of a rebound, but ultimately prices worked lower. There is little doubt (and we've said this before) that the relatively-high "real" rates (as opposed to the nominal rates) gave the Fed some wiggle room, and given the world's state-of-affairs, they may need it. Certainly, they've known that for months; and surely the premature dropping of rates by the Japanese must have been on their mind for months already. (But our PE remains very risky.)
What we are seeing is the Fed admitting a black-hole loomed, and that they understood the full panic in the investment community, despite the financial media's relative civility in explaining all of what's been going on to investors. The Budget Bill's passing, IMF funding approval, and quick basic bailout of Brazil, were hardly noticed in the day's late going, but have something to do with what increasingly is shaping-up as Washington's coming-to-grips with problems that do matter.
Let us pray that this great step back retards others' recent Hooveresque monetary policies , is a positive abroad, but without destabilizing our domestic economy further. The real risk (and that is why a precise pronouncement that the Bear is over based on today's move is impossible and in fact reckless) is that the Dollar weakens so much as to trigger a massive selling-wave of dollar denominated assets; a touch of which we've already witnessed. Yes; this all falls under the type of derivatives crisis and implosion risks warned of starting last year; though not all of it is solely debt-based. What I'm trying not to say; is that this series of actions may be a last best chance to save an historically unprecedented intertwined international derivatives mess from total collapse.
Gene Inger,
Publisher,
www.ingerletter.com
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