What a Week: Electroshock Rate-Cut Therapy Can't Sustain Market's Spirits

SAN FRANCISCO -- Maybe it was a dream, or just a mirage. Because save for a gargantuan rally Wednesday inspired by the Federal Reserve's intermeeting rate cut, it was another rough week for those long.

The Fed's decision to lower the fed funds rate by 50 basis points clearly defined a holiday-shortened week that somehow felt longer. But even the enormity of the post-Fed celebration/relief couldn't prevent major averages from falling for the week. The Dow Jones Industrial Average slid 1.2%, the S&P 500 shed 1.7%, and the Nasdaq Composite lost 2.5%.

Friday's session concluded the week on a decidedly dour note. A weak employment report, combined with continued concern about the profit outlook for companies such as Cisco Systems (CSCO Quote - Cramer on CSCO - Stock Picks), analyst downgrades of Applied Micro Circuits (AMCC Quote - Cramer on AMCC - Stock Picks) and 3M (MMM Quote - Cramer on MMM - Stock Picks), and disappointing news from companies such as CV Therapeutics (CVXT Quote - Cramer on CVXT - Stock Picks) (among many others) helped send the Dow down 2.3%, the S&P 2.6% lower, and the Comp south by 6.2%.

"It's going to be a difficult time -- a continuing process -- to turn investor psychology and the 'sell-the-rallies' mentality," one market watcher observed Friday afternoon. "Is all the bad news out? Obviously not."

New Year, Same Story?

The hope and anticipation that greeted the new trading year was replaced by fear and consternation Tuesday morning after the National Association of Purchasing Managers' survey posted its lowest reading of manufacturing activity since April 1991. The fact that occurred during the last recession was not lost on market participants, who sent the Dow down 1.3%, the S&P lower by 2.8% and the Comp off 7.2%, its seventh-largest percentage drop ever.

Concern about the NAPM report was accompanied by a realization that tax considerations did not cease on Dec. 31, 2000. Some investors saw the new year as a time to book profits in some of 2000's big winners, including Brocade Communications (BRCD Quote - Cramer on BRCD - Stock Picks), Juniper Networks (JNPR Quote - Cramer on JNPR - Stock Picks), Check Point Software (CHKP Quote - Cramer on CHKP - Stock Picks) and Veritas Software (VRTS Quote - Cramer on VRTS - Stock Picks). Each closed off more than 15%, contributing to a 9.1% drop for the Nasdaq 100.

The action frightened investors, as reflected when Tuesday subsequently proved to be the biggest single day of outflows from mutual funds ever.

So great was the pain in equities that a collective cry for relief went up from both Wall and Main streets. And by outward appearances, Fed Chairman Alan Greenspan heeded them.

The Fed's rate cut Wednesday afternoon stunned everyone (none more so than this reporter). Even those clamoring for an intermeeting ease surmised the Fed would wait until after Friday's employment report, and then trim by 25 basis points.

Because a rate cut prior to the jobs data, especially one of 50 basis points, was so unexpected, the Fed's gambit paid immediate dividends. After the central bank's announcement at around 1:15 p.m. EST, stocks exploded upward.

Once as low as 10,367.19, the Dow closed up nearly 300 points, or 2.8%, to 10,495.75. The S&P closed up 5% to 1347.56 vs. its intraday low of 1274.62. From its opening low of 2251.71, the Nasdaq soared to close up 324.82, or 14.2%, to 2616.68.

The advance was the Comp's biggest ever in percentage and point terms, while trading volumes eclipsed previous highs in both over-the-counter and NYSE activity. Meanwhile, the bond market regurgitated much of the prior day's gains.

Don't fight the Fed, indeed.

Why They Did It, Alice

That stocks dipped modestly Thursday did little to dispel the enthusiasm.

"The way the market traded Wednesday was reminiscent of [the] late 1990s -- people felt good about that and should have," said Brian Belski, fundamental market strategist at U.S. Bancorp Piper Jaffray in Minneapolis. "It was a monumental reversal and discipline shift. You saw it [Thursday] even though the market was soft: There was heavy rotation out of drugs and energy and into tech" and cyclical names.

Friday, however, was a different story, he conceded. With the jobs report coming in not as weak as some had feared, market players redoubled speculation that Greenspan had motives for lowering rates beyond the economic slowing and fears thereof. (The NAPM data, myriad layoff and bankruptcy announcements, Thursday's same-store sales figures and Friday's employment report -- even if it wasn't dreadful -- confirmed the economy's downward thrust.)

By cutting rates, the very day President-elect Bush was holding an "economic summit" in Austin, Texas, some mused Greenspan wanted to send a message that the Fed, not the White House, runs the economy. Or maybe the chairman, who has said he'd prefer to see the budget surplus used to pay down debt, wanted to pre-empt (or sabotage) "W's" tax-cut proposal. Or both.

Another theory gaining credence was that the rate cuts were an attempt to help California's struggling utilities avoid bankruptcy, and the devastating economic consequences that blackouts in the state, notably Silicon Valley, might generate (pun intended).

Furthermore, concern about banks' exposure to the California utilities was mounting and weighing heavily on sentiment Friday. Bank of America (BAC Quote - Cramer on BAC - Stock Picks) denied rumors it was suffering heavy losses, but its shares still fell 7.3%.

The California Public Utilities Commission approved 7%-to-15% rate increases for customers of PG&E's (PCG Quote - Cramer on PCG - Stock Picks) unit Pacific Gas & Electric, and Edison International's (EIX Quote - Cramer on EIX - Stock Picks) Southern California Edison division on Thursday. But both utilities had said rate increases of at least 20% were needed in order to avoid bankruptcy. In reaction to the CPUC's decision, credit-rating agencies lowered the utilities' debt to either junk status or one notch above.

Given rising speculation the utilities will attempt to access the debt markets to avoid bankruptcy, the Fed's rate cut was looking like an effort to pave the way by jump-starting the previously moribund junk bond market.

That XO Communications (XOXO Quote - Cramer on XOXO - Stock Picks) and McLeodUSA (MCLD Quote - Cramer on MCLD - Stock Picks) were able to successfully price high-yield bond offerings Thursday was evidence the rate cuts were already proving successful.

But the action in equities this week indicates the Fed still has a lot more work to do.

"It's fairly clear the fixed-income part will be easier to do, but it's going to take some time for the equity market -- and the new-issue market -- to get going again," Belski said. "There's not going to be an overnight solution. We're starting to get into earnings crunch time and the market is going to be vulnerable to earnings gyrations."