No Emotional Rescue by the Fed

Millions of investors' hopes and dreams are in the hands of the once-revered Alan Greenspan . It doesn't matter that much of the economic data refutes the notion of a ship taking on water fast. If he only cuts rates by 50 basis points, his onetime fans are apt to storm the castle. The Fed head could be exiled to Main Street.

Last week's miserable action was quite painful and ugly. More than a few clients and friends commented that the selling really picked up upon my return from Europe. They'd like me to go back. However, I'm leaving for Hawaii next Wednesday, so perhaps that'll be far enough away to suffice. Obviously, most of the bulls are wishing that the Fed's move Tuesday will stem the market's fall, but I'm afraid that the Fed is also powerless to end the nose dive in the immediate future. And I believe the Fed knows it, which is why I don't think a much-hoped-for 75 basis-point rate cut is forthcoming Tuesday.

How spoiled have we become? If I'm right about the outcome of the Federal Open Market Committee meeting (and I'm not terribly confident about that, given the state of affairs in Japan), market pundits will wail and whine that the Fed isn't being aggressive enough. Cutting rates by 150 basis points in 11 weeks is hardly a passive approach, but it won't be enough to turn the market, which is what perma-bulls still expect to happen. (It's that V-shaped thing, you know.) In my opinion, the market's primary problem isn't that monetary policy was too tight or interest rates were prohibitively high.

The Real Issue

A speculative asset bubble is being deflated. Massive malinvestment, excessive borrowing and wild speculation caused by the Fed's easy money policy in the 1990s must be unwound before we can embark upon a new cycle. And, if that's the case, a 75 basis-point cut would also fail to breathe life for very long into a bull that's already dead. Be careful what you wish for. Easy answers are rarely the best, and we're all in favor of long-term growth and stability.

While industrial production continued to head south, the University of Michigan's preliminary reading of consumer confidence inched higher, which reduced the likelihood of a 75 basis-point easing. However, a Newsweek poll now shows that 71% of Americans expect a recession. There's a good chance that they'll act accordingly and begin paying down debt and saving more. That's good news for longer-term economic health, but it could make the near-term outlook sickly. A better-than-expected producer price index report had little impact on trading outside bondland, as there's an increasing concern that deflation is a greater risk than inflation, even as prices at the consumer level have risen year over year. In any event, slightly more than half of the primary dealers in government bonds expect another 50 basis-point cut, but fed fund futures were pricing in a 72% chance that 75 basis points are in store tomorrow.

If there was any lesson to take away from last week's dismal trading, it was that now even the most obtuse observers could see that the damage has not been isolated to just the tech and telecom sectors. The Dow's weekly plunge of 821 points (7.7%), topped off by Friday's decline of 208, was its largest ever, and its percentage decline was larger than any quarter over the past 10 years, with the exception of one. The S&P 500's decline was a shade less at 6.7%, and the Nasdaq Composite Index's loss of 7.9% only a tad worse. The Wilshire 5000 lost 6.8% on the week and has now fallen more than 26% year over year. The bear is stretching its legs and threatens to claw its way through the entire market before lumbering back to its cave.

The Week Ahead

OPEC's 4% production cutback failed to take the market by surprise, and crude closed well off its highs. Lower energy prices at the consumer level in the immediate future aren't a good prospect, as the lack of investment throughout the '90s is coming back to haunt us now. And it looks like the feds in Washington might look to change the rules again -- not exactly good news for many utility companies, but it could provide a needed infusion of fees to Wall Street. We might see a mad dash to spin out nonregulated businesses before the government has time to act. Bear Stearns, Goldman Sachs, Lehman Brothers and Morgan Stanley Dean Witter will be reporting earnings this week, and it will be interesting to see what kind of picture they'll paint for the balance of the year.

With almost nobody concerned about inflation and few still relying on the consumer price index to measure it, Wednesday's report will be an anticlimactic event after the Fed's announcement Tuesday. Sentiment indicators have become a bit more bearish, although the Ameritrade Index remained high Friday, but almost everybody seems bearish on tech stocks except Abby Joseph Cohen. I continue to believe that shorting nontech stocks, particularly electric utility, energy (ex natural gas), financial, retail and transport stocks offers a much better trade on a risk/reward basis. Of course, being aggressive ahead of Tuesday's meeting is risky, but shorting nontechs appears to be the best way to play the game on any strength.

Although the forecast is fairly gloomy on Wall Street, the sun is shining brightly in New York. Perhaps the best bet is to skip a day, get some rest and wait until the smoke clears after the Fed meeting. Be careful out there.