Feding Frenzy: Bulls Encouraged by Hoped-For Fed Easings Gorge on Stocks

SAN FRANCISCO -- Another day, another profit warning from a tech bellwether, and yet another collective shrug from the major averages. Weighed down by, but certainly not waylaid by, weakness in PC-related stocks, the Dow Jones Industrial Average fell 0.1%, the S&P 500 rose a fraction and the Nasdaq Composite Index lost 0.5% today.

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The ability of Dell (DELL Quote - Cramer on DELL - Stock Picks), which fell 0.5%, and the broader market to largely ignore this latest red flag supports the bulls' belief the "bad news" is already incorporated into current prices.

"Lower profit numbers do not reduce our market optimism," wrote Thomas Galvin, U.S. portfolio strategist at Credit Suisse First Boston today. True to his word, Galvin reduced his forecasted S&P 500 earnings growth to 7% from 8% for the fourth quarter and to $61 a share for all of 2001 vs. $63. Yet he maintained a year-end target of 1600 for the S&P 500, roughly 20% above today's close.

The strategist's optimism stems from a view that "the inflation scene is incrementally improving," as demonstrated by December's Consumer Price Index, recent declines in natural gas prices and competition among retailers keeping prices lower. The absence of inflation, plus California's utility crisis, increases the odds the Fed will continue to ease, he concluded.

That the central bank will ease at its Jan. 30-31 meeting seems a foregone conclusion, and fed fund futures are predicting another 50 basis-point cut next week and additional rate cuts thereafter. But the question remains whether the Fed is too late to prevent a recession, and how that affects corporate earnings.

As you might expect, those optimistic about stocks are putting their faith in the Fed.

"As long as the Fed is easing to ensure that a soft landing doesn't get harder, the stock market should be rebounding," Jeffery Applegate, chief investment strategist at Lehman Brothers, wrote today. Because the easing process has begun, "the stock market should be going up" now, even if it turns out the economy is already in recession (which can't truly be determined without benefit of hindsight). If the U.S. economy is currently in recession and doesn't begin to recover until the second quarter, "the stock market trough should have been several months earlier, or sometime in the fourth quarter of 2000," Applegate theorized.

Such an outlook might have more credence if the strategist hadn't repeatedly said that the market had bottomed last year. Still, market action seems to be supporting his argument that "soft landing or recession, the stock market should be in the process of recovering and the yield curve should be steepening."

The stock market has fared pretty well so far in 2001, while the spread between yields on two-year notes and 10-year bonds has now widened to almost 90 basis points from 33 at the beginning of January, Reuters reported. In other words, the yield curve is steepening.

In the microcosm of Dell's warning, the discussion revolves around how Fed easing will affect capital expenditures on tech products, as reviewed in RealMoney.com's Columnist Conversation and an article by TheStreet.com's Justin Lahart today. Similarly, Adam Lashinsky raised concerns about Microsoft's (MSFT Quote - Cramer on MSFT - Stock Picks) outlook last week, noting the software giant's dependence on global economic growth.

U.S. monetary policy will have a lot to say about corporate spending on tech and global growth. But for stock pickers, "it all comes down to more money supply [and] using lower interest rates when you're discounting earnings," said Brian Belski, fundamental market strategist at U.S. Bancorp Piper Jaffray in Minneapolis. "That's the big part."

Along with Intel (INTC Quote - Cramer on INTC - Stock Picks) and JDS Uniphase (JDSU Quote - Cramer on JDSU - Stock Picks), Belski recommends Dell as his favorite "mega-cap, varsity A-team players" in tech/telecom. The "premier names" in the sector are back in favor because their liquidity offers investors the ability to "reverse course if the market/sector turns sour again, yet participate on the upside while the current trend is in vogue," Belski said. (His firm has not done underwriting for Dell, Intel or JDS Uniphase.)

In terms of Dell's actual business outlook, an admittedly simple (and optimistic) way to look at Fed easing is that it will allow companies to more readily raise money in the debt markets, and they can use those funds to buy more PCs and related equipment.

On the retail front, Fed easing already has put funds in consumers' pockets through mortgage refinancings. At current rates, refinancing activity could save consumers around $10 billion in interest costs this year, according to Merrill Lynch chief economist Bruce Steinberg.

"The additional 100 basis points of Fed ease that we expect should support more refinancing activity during the first half," wrote Merrill chief U.S. investment strategist Christine Callies in a separate report. Lower monthly mortgage payments and workers' continued optimism about the job market (despite the layoff announcements) "are reasons why the consumer side of the economy is probably resting, not dead."

On the Other Hand

The naysayers include Lehman Brothers analyst Dan Niles, who recently forecast information technology budgets at Fortune 500 companies this year will be as much as 5 percentage points below the 10% growth that International Data Corp. forecasts.

Niles couldn't be reached for additional comment.

Elsewhere, Doug Cliggott, equity strategist at J.P. Morgan, took on this issue in a report today.

Central to Cliggott's outlook is a belief current consensus estimates for S&P 500 earnings are still too high. "Slower revenue and [earnings-per-share] growth means downward pressure on cash flow," he wrote. Because of the "tight relationship" between earnings growth and business spending on computers, "the oncoming deceleration in tech spending is more likely to be sharp than gentle."

Investing in technology infrastructure is a requirement for corporations' economic survival, he conceded, suggesting that it will keep tech spending growing faster than GDP overall. "But we doubt it guarantees fast growth in each and every quarter [and] think the risk to technology spending is definitely to the downside," which means the 16% expected earnings growth for tech this year may prove optimistic, Cliggott concluded. "We will probably see a couple more waves of 'limit down' days during the next six months before it is really the right time to build a lot of new technology exposure."

But given the way the market is acting, and the fact more Fed easing will boost potential spending on tech by individuals and corporations, it seems the onus is once again back on the skeptics.