Stocks Fail to Respond After Fed Rate Cut
The Federal Reserve on Tuesday gave the stock market seemingly everything it craved: a half-point interest rate cut and the hint of more to come.
Yet stocks responded with the Wall Street equivalent of a yawn, with the Nasdaq composite index inching up about 4 points and the Dow Jones industrial average easing 4 points.
More than a one-day event, the blase reaction might be a harbinger of things to come, some analysts said.
Rate-cut enthusiasm has propelled stocks for more than six weeks. But most of the gains came between the Fed’s cuts March 20 and April 18. In the last few weeks, major indexes have made little progress.
Even if the Fed further reduces rates in coming months, the market might be held back by other forces--mainly, still-depressed corporate earnings and sharply rising long-term bond yields, experts said.
The bottom line for investors: Stocks may languish in a narrow trading range until the economy--and profits--show unmistakable signs of improvement. And that could be months away.
At the same time, many equity investors might want to see bond yields stabilize before committing more heavily to stocks.
The basic issue, many experts said, is that the Fed has done about as much as it can for the market. It has dropped rates aggressively, to seven-year lows, and shown a willingness to do more.
But now, with price-to-earnings valuations on many stocks still historically high, some investors want to feel more confident that lower rates will filter through the economy and translate into fattened corporate profits, analysts say.
“It’s going to be earnings driving the market, not the Fed,” said Timothy Morris, chief investment officer at Bessemer Trust in New York. “It’s really an earnings question for the market in the next couple of months.”
The problem, however, is that earnings overall are unlikely to turn around until the fourth quarter at best, and some experts doubt they’ll improve until early 2002, given soaring energy costs, rising wage pressures, heated competition and waning worker productivity.
Wall Street also is grappling with the sudden jump in bond yields. After rising again Tuesday, the yield on the benchmark 10-year Treasury note has climbed to 5.50% from 4.76% in late March.
In a sense, rising yields are bullish for stocks because they indicate that the economy is gaining steam. But they also hurt stocks by raising corporate borrowing costs and luring some investors out of stocks and into bonds.
“Profits are not strong enough right now--nor will they be in the next year--for stock prices to withstand higher yields,” said Jim Paulsen, chief investment officer at Wells Capital Management.
Stocks’ powerful rally since early April has been fed by the belief that the economy will rebound by the fourth quarter. Because stocks historically rally six to nine months in advance of a perceptible economic pickup, investors have plowed back in.
Even with a modest slide in the last week, the Nasdaq index still is up 27% since April 4. The Standard & Poor’s 500 is up 13%.
But some Wall Street professionals worry that corporate earnings may not pick up much even if the economy does. They fret that profits may muddle along into next year even if the economy avoids recession.
Indeed, that’s the message coming from some technology and manufacturing companies. Executives in those sectors continue to lament their still-sliding sales.
“Over the next three to six months, the debate is going to change from whether we’re in a recession to whether we’ll ever get out of sluggish growth,” Paulsen said. “It seems subtle, but it’s night and day to the stock market.”
The market’s immediate roadblock may be corporate earnings “pre-announcements.” Already, more than 300 companies have warned that their second-quarter earnings will fall short of expectations. That number will almost certainly rise toward the quarter’s end June 30.
So far, however, earnings-tracker Thomson Financial says most of the warnings are coming from smaller companies rather than the big names that dominate key stock indexes.
Though institutional investors avow that they will look beyond what are certain to be bad second-quarter numbers for many companies, the daily barrage of bad news probably will weigh on stocks.
Ironically, stronger-than-expected economic data in the next couple of months may not help the market if it continues to drive bond yields higher without also boosting investors’ trust in a corporate earnings rebound.
But some experts say the fears are overdone.
Tobias Levkovich, equity strategist at Salomon Smith Barney, did a study this week assessing how stocks fared in periods when the Fed stopped cutting interest rates while corporate earnings remained weak. In other words, could stocks move higher before lowered rates translated into higher profits?
He found four quarters in the last two decades when rate cuts had ended and earnings were still dropping. Yet the market rose in each of those periods between 5% and 15%. So “there’s some history on [the market’s] side,” Levkovich said.
Indeed, some sectors of the market are showing encouraging signs.
Smaller stocks have outpaced the S&P; 500 in recent weeks, and some experts said the market’s next upward leg--whenever it occurs--will be driven by lesser-known companies.
But Santa Monica hedge-fund manager David Ryan said there simply aren’t enough strong stocks to convince him that a major upward move is on the horizon.
“We’re not in a bull market. We’re not in a bear market,” he said. “It’s more of a back-and-forth marking of time.”
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Profit Forecasts by Market Sector
In the current quarter, Wall Street analysts project that operating earnings for the Standard & Poor’s 500 companies will fall 11.4%, overall, from a year earlier as the economy remains weak. Even in the third quarter profit growth is expected to be minimal or negative for about half the 11 major industry sectors in the S&P; index. Analysts’ projections for the next three quarters, by sector:
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Estimated change in operating profit from the same period a year earlier: Sector 2nd qtr. 3rd qtr. 4th qtr. Technology -51% -39% -13% Financials +5 +10 +27 Health care +12 +12 +14 Consumer staples +3 +10 +20 Capital goods -1 +8 +14 Consumer cyclicals -19 +6 +20 Energy +8 -9 -19 Communications -32 -20 +1 Utilities +9 +18 +14 Basic materials -40 -17 +11 Transports -32 +1 +41 S&P; 500 total -11.4 -2.8 +8.9
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Source: Thomson Financial
Waning Gains
Major stock indexes have posted only small gains since the Federal Reserve’s interest rate cut on April 18, and moved little Tuesday despite the latest cut. By constrast, stocks surged between the Fed’s March 20 and April 18 cuts.
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Nasdaq composite
March 20-April 18: +12.0%
April 18-Tuesday: +0.3%
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Dow industrials
March 20-April 18: +9.2%
April 18-Tuesday: +2.4%
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Sources: Times research, Bloomberg News
