Financials Loving Our Man Greenspan, as He Accentuates the Negative

What He Say? What He Say?

SAN FRANCISCO -- Financial markets did a little dance and eventually found a little love today as Alan Greenspan got down before the Senate Budget Committee.

For a switch, more of the drama was in the bond market, where prices tumbled after the release of the chairman's prepared comments. Bond traders were disappointed at the lack of specifics regarding monetary policy and fretted about the possible stimulus from tax cuts, which Greenspan largely supported.

But as Greenspan took questions from the senators, he was forced to talk at length about the economy. And he chose to accentuate the negative, which reinforced hopes the Fed will lower interest rates by 50 basis points next week.

"The Q&A was telling as [Greenspan] chose to emphasize the slowing in the economy rather than the bright aspects," noted Tony Crescenzi, chief bond market strategist at Miller Tabak. "Where were the comments about the soundness of the financial system, or our economy's ability to withstand stress? Yield spreads coming in? Or the continued low unemployment rate? They were lacking."

Greenspan also failed to mention the recent recovery in retail sales or the salutary effect of mortgage refinancings and the (still) strong dollar. But the chairman made the following observations, either in prepared testimony or during the Q&A (the latter culled from newswires):

• Productivity growth has been sustained despite "a pronounced slowing in the growth of aggregate demand during the second half of last year."

• "We have had a very drastic slowing down and indeed we are probably very close to zero [economic growth] at this particular moment."

• Recent data -- including this morning's employment cost index, jobless claims and existing home sales reports -- "affirm that inflationary pressures are exceptionally well contained at this particular stage. [Simultaneously], we are seeing that economic growth has slipped very dramatically."

"I believe the lack of emphasis on the positive and degree [of emphasis] on the negative in the economy suggests he's hinting at 50 [basis points], not 25," Crescenzi said.

The bond market seemed to agree; the fed funds futures contract for February is currently pricing in a 90% chance for a 50 basis-point ease. The 30-year bond rose more than 1/2 point today, its yield declining to 5.32%. The 10-year bond rose more than 1/4 point to yield 5.32%. Shorter maturities did not fare as well, but observers noted that 2-year notes, particularly, were able to rally back to unchanged after being down sharply early in the day.

Another indication that the market expects aggressive Fed easing came from the Dow Jones Industrial Average, which rose 0.8% as cyclical (i.e., "economically sensitive") names rallied, including United Technologies UTX, Wal-Mart WMT, International Paper IP and Boeing BA. Merck MRK and Johnson & Johnson JNJ were also big Dow gainers.

On the Other Hand

However, the Nasdaq Composite tumbled 3.7% and the S&P 500 shed 0.5% as technology stocks retreated. The Nasdaq 100 dumped 4.8%, while the Philadelphia Stock Exchange Semiconductor Index slid 4.1%.

But those declines probably had little to do with Greenspan. Traders said the Nasdaq hit "negative technical divergences" on Monday. That the index continued to rise thereafter only enhanced the inevitability of a retreat.

"We needed to pull back," said one otherwise bullish market participant, who forecast the Comp will likely retreat to support levels around 2650, at worst. (Similarly, Todd Harrison has pegged 2550 as near-term support for the NDX.)

Most important to today's tech setback was the news from Corning GLW, according to Ned Riley, chief investment strategy at State Street Global Advisors.

"We've finally hit one big company that didn't provide ammo and encouragement people needed to keep the rally going," Riley said. Corning's announcement about slowing IT spending and weaker first-quarter results starkly contrasted to the "more upbeat" guidance from IBM IBM and Dell DELL, among others, he said. "Corning's announcement brought sobriety [and] reality back into the tech area, which was moving on shreds of good news [before] Corning's announcement hit today."

That said, Riley decried the "typical lemming reaction," which sent Corning's shares down nearly 20%, suggesting Wall Street is "ignoring the long-term capabilities" of the company.

Riley declined to discuss State Street's specific holdings, but the fund family is long Corning, Dell and IBM, according to BigDough.com.

What'll It Be Boys?

As with all things Greenspan, there was something for everyone in the testimony. "His remarks were on both sides of the fence," said Anthony Karydakis, senior financial economist at Banc One Capital Markets in Chicago. "Pretty much people have maintained the views they've had up until now."

Karydakis admitted having little conviction but continues to believe the Fed will ease by 25 basis points, noting the potential stimulus of tax cuts -- which the chairman supported -- may mean the Fed will have to ease less aggressively.

Speaking of little conviction, and acknowledging my recent (ahem) spotty track record for predicting Fed actions, the pick here is that it will go 50 basis points.

In addition to the aforementioned dour comments on the economy, Greenspan also made the following statements during the Q&A:

• "Clearly California is a very important part of the American economy. It's scarcely credible that you can have a major economic problem in California which does not feed to the rest of the 49 states."

• "The problems we are now seeing in the energy area, obviously natural gas [prices] and very obviously California's electric power production are not aberrations but ... a significant problem that this country is going to have to address and address rather quickly."

Clearly Greenspan was, and is, worried about the economic impact of the state's utility woes, as well as the potential threat facing large financial institutions exposed to Edison International EIX and PG&E PCG.

Finally, there is the market itself. Without rehashing the whole moral hazard debate, a Nasdaq retreat now could give the Fed "cover" to be aggressive. State Street's Riley, among others, has recently argued the Nasdaq is now the most important economic indicator there is, because of its direct impact on consumer confidence.

The irony being that investors hoping for 50 basis points of ease next week should wish for more short-term weakness now, which news after the bell, notably from JDS Uniphase JDSU, BroadVision BVSN and PMC-Sierra PMCS, might help precipitate.

That said, the prospect for additional Fed ease plus tax cuts is a recipe for being long financial assets.