How A Fed Rate Cut Impacts Stock Prices
The Fed Is Ready For another Rate Cut… Here’s What It Means For Stock Prices
Friday, February 01, 2008: Issue #492
By Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report
The Fed wielded the axe and cut the benchmark interest rate by 0.75% to 3.5% - its biggest ever one-day Fed rate cut.
The move came after a tumultuous day that saw stock indexes across the globe plunge amid mass fears of a U.S. economic recession. As the financial sector crisis and real estate slump worsens, yet energy prices and consumer debt soars, investors battered the markets, sending several to their worst one-day losses in many years).
Cue, Fed Chairman Ben Bernanke, who cancelled a trip to New York and hastily organized an emergency meeting with his fellow Fed bankers.
The board overwhelmingly voted to slash interest rates before its scheduled meeting. And the bankers aren’t done yet.
Along with a proposed $150 billion package of tax relief and incentives from the Bush administration, the Fed’s statement strongly hinted that it will cut rates again. Let’s see what this means for the stock market…
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A 1.25 Percent Rate Cut In 8 Days
The increasingly few people opposed to further interest rate cuts argue that it will crush the U.S. dollar and spark even higher inflation. Valid points, but the fact that the stock market has stabilized somewhat shows that investors value Bernanke’s leadership and clear messages of intent.
The consensus is for a further 0.5% cut, taking the benchmark rate down to 3% - a 1.25% reduction in just over a week. Right now, Fed funds futures show a 74% chance of a 0.5% cut, with a 0.25% reduction fully priced in. And since the Fed seems to be listening to the markets more closely now, we’re likely to get another cut.
This will probably help push stock prices higher over the short-term, but the question on everyone’s mind is: Will it last? Here’s what the charts say…
Bring Out The Bears As A Five-Year Trendline Is Busted
Because it represents the broader stock market, we’ll deal with the S&P 500 here.
The first thing you’ll notice on the weekly chart below is that the index is currently trading about 65 points below its five-year uptrend line, dating all the way back to the bear markets lows in October 2002.
That’s a clear bearish sign, which increases the odds that the stock indexes have some unfinished business on the downside.
That said, however, the trendline currently comes in around 1,420 and if the index can close above that level, there is some hope - especially at the end of the month. This is because on a monthly basis, January would be the first month that it’s closed below the trendline. If it can avoid that, the bulls could take back control.
Critical Number: 1,420
A look at the daily chart of the S&P 500 really shows just how important that 1,420 area is. A 50% Fibonacci retracement drawn from the highs in October 2007 to the recent lows comes in at 1,423. And in order to set up a daily buy signal, using the ESP Profit System, the S&P needs to first trade above 1,410.
While closing above 1,420 at the end of the month seems a tall order, stranger things have happened - particularly with the Fed trying to propel the market forward again.
If that fails to occur, any rally up to the 1,400-1,420 area on unimpressive volume and poor advance-decline readings, should be used to lighten up on long positions, or hedge against them. If you’re an aggressive, intermediate-term trader, you could use this scenario to short the stock indexes, using a definitive weekly close back above the trendline as a stop-loss point.
Fed Rate Cut Doesn’t Guarantee Success
While the Fed is using all its monetary policy power to jump-start the economy and stock market back to life, its powers are limited if the market doesn’t want to play ball.
In addition, while cutting rates can be an effective way to prop up the market, it can also be a somewhat artificial and temporary tool that merely papers over economic/market cracks without allowing the market to fully correct the situation for itself.
So if the selling resumes, you could use it as an opportunity to employ some downside investment strategies. Some of the stocks on my bearish watchlist that should make new lows are:
- Rick’s Cabaret (Nasdaq: RICK)
- Triquint Semiconductor (Nasdaq: TQNT)
- First Solar (Nasdaq: FSLR)
- Thor Industries (NYSE: THO)
- Interactive Corp. (Nasdaq: IACI)
Good investing,
Jim stanton
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Today’s Smart Profits Action Center:
- More concerned with the stock market and what Wall Street wants than the overall economy and inflation rate. That’s the charge that some economists are leveling against Ben Bernanke in the wake of last week’s 0.75% interest rate cut and the likelihood of a further cut on Wednesday. And following a Commerce Department report today that showed a 5.2% jump in December durable goods orders - the biggest rise in five months - some are wondering if another rate cut is even necessary.
- But also weighing on the Fed’s mind is the fact that figures released this morning from RealtyTrac show that U.S. home foreclosure filings rocketed up by 75% to 2.2 million in 2007, compared with 2006 numbers. A late-year surge pushed the figures higher, as the subprime mortgage crisis began to bite, on top of already debt-laden consumers. Fourth-quarter filings shot up 86% over Q4 2006, while December filings ballooned 97% to 215,749, compared with December 2006 - the fifth straight month that filings exceeded 200,000. At 3.4% of total homes, Nevada took the dubious honor of having the nation’s highest foreclosure rate (up a staggering 200% over 2006), while led the way in terms of total foreclosure filings and homes in some stage of foreclosure. This on top of news that new home sales slumped by 26% in 2007 - the worst year since 1963.
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