Market Bullheadedly Ignores Missed Earnings, Salivates for Rate Cut

GuruVision: Fed Trumps Fundamentals

SAN FRANCISCO -- "Earnings are dead, long live interest rates!" That proclamation, heard from a growing number of traders lately in reference to short-term market influences, was on obvious display today.

Sidestepping the cautious comments from Cisco Systems CSCO, the Dow Jones Industrial Average rose 0.4%, the S&P 500 gained 0.7%, and the Nasdaq Composite Index rose 2.1%. Meanwhile, the Nasdaq 100 gained 2.4%.

Even Cisco seemed immune to its own devices, closing off 2.9% at $37.25 after trading as low as $35.50.

"The Cisco news came and went -- people blinked and went on to the next thing," said one West Coast trader. "We've seen a lot of this lately. The negative impact [of slowing earnings] is behind us and people are looking out six months to see what happens in the economy."

Still, the trader wondered how long the upward momentum can last "if things don't turn around" on the economic front. A big key to that, of course, will be the Federal Reserve, from which most expect another 50 basis points of easing this week.

Projections for more aggressive rate cuts -- and the added bonus of potential tax relief -- captured the hearts and minds of the gurus this week. Here's a sampling of their weekly comments:

"Winning is easy when the Fed is on your side," according to Edward Kerschner, chief global strategist at UBS Warburg. "Don't fight the Fed. Don't fight a cheap market. Never fight both!"

"Marginal tax-rate cuts ... along with sizable cuts in interest rates, should cause some sizable amounts of cash to move from the sidelines," wrote Greg Smith, chief investment strategist at Prudential Securities. "This inflow of cash should create a pretty big rally."

"The growth capital window is reopening, liquidity premiums are falling and [price-to-earnings] multiples are rising," commented Thomas Galvin, U.S. portfolio strategist at Credit Suisse First Boston. "One could argue that our current year-end price targets of 4000 for the Nasdaq and 1600 for the S&P are too conservative."

"The combination of tax cuts and easier Fed policy should be a significant positive for equities in 2001," according to Christine Callies, U.S. investment strategist at Merrill Lynch.

"We reiterate our view that the current market environment is very comparable to that of 1995 [when] the market rallied strongly despite a slowing economy," wrote Robert Robbins, chief investment strategist at Robinson-Humphrey in Atlanta. "We continue to forecast a 24% rise in the S&P 500 to approximately 1690 by year-end 2001."

"Avoid overanalyzing the gyrations and stick with the macro themes: Lower interest rates help stock prices," observed Brian Belski, fundamental market strategist at U.S. Bancorp Piper Jaffray in Minneapolis. "Lower interest rates especially help growth stocks."

You get the concept. But can it really be that there's no risk to owning stocks for the next year? Before attempting to answer that, recall that many of the aforementioned gurus were bullish throughout much of 2000. (Even Kerschner, who presciently warned of risks in March, got back on the bullish bandwagon too soon.)

Gotta Have Faith

Judging by the market's gains thus far in 2001 and again today, investors (and gurus) are clearly putting their faith in the Fed's ability to revive the economy, and thus prospects for corporate earnings.

In a quick change worthy of the catwalk, it has recently become fashionable for economists to talk openly about the possibility of recession. But most observers express confidence the Fed will take appropriate action. Thus, the biggest risk to the optimists is if rate cuts and/or tax cuts prove unable to stop the economy from careening into full-blown recession (or deeper into it for those who believe we're already in a recession).

"The market feels the Fed will do what it takes [to prevent recession] but people are buying into the V-shaped recovery" scenario, said William Dudley, director of U.S. economic research at Goldman Sachs. "Too much so in my opinion."

Dudley forecast a 1-in-3 chance the economy falls into recession in a report Friday, predicting the Fed could thus have to move far more aggressively than most investors currently expect. "The historical record as well as current circumstances suggest that Fed officials could ease by an additional 200 to 300 basis points," with 150 to 200 coming this year, he wrote.

Splitting the difference, 250 basis points of easing would ultimately take the fed funds rate to 3.50%, far below the popular expectation that it's heading back toward 4.75%, the level from which the Fed began tightening in June 1999.

Dudley believes the bond market -- in which long-dated securities fell today for the sixth time in seven sessions -- is currently not priced for such aggressive Fed easing. He recommends buying bonds in general and going long the March Treasury bond futures at 102.30, specifically, with a target of 107.00 and a stop on a close below 101.08.

The economist did not discuss equities. But Dudley's commentary recalled Don Hays, of Hays Advisory Group in Nashville, Tenn., whose overriding outlook is predicated on a belief that extensive Fed rate cuts will prove unable to prevent the economy from falling into recession. Realization of that fact will undermine investor confidence, he believes, and bring on the harrowing "third phase" of the bear market, beginning sometime between April and June.

In a report today, Hays suggested the Nasdaq is "probably ready for a two to four week rest that could take as much as 14% off its current level, maybe back to 2500."

But such a decline would end only the first of what Hays expects to be three rallies in the Comp's "interlude phase" before the bear market resumes in earnest. The three-rallies prediction is based on an expectation the Comp will continue to follow the pattern of the Nikkei Dow, specifically its "interlude rally" phase between Oct. 1, 1990, and May 1991.

Hays recommended traders "nail down your profits and try to pinpoint the next bottom," which he predicts will occur in the next four to five weeks. For investors, he suggested "riding out the first couple of waves, with the intent of taking profits at the last peak of this interlude rally."

Market conditions permitting, tomorrow we'll examine another alternative: that the economy isn't as weak as some fear, and that the combination of Fed ease and tax cuts will reignite inflationary pressures.