What a Week: Greenspan Provides, but Market Can't Take Delivery

SAN FRANCISCO -- If "everybody" knows something is going to happen, does that intensify its ultimate occurrence? Or does widespread expectation of a given event dilute or alter the ultimate outcome?

Heading into this week, the overwhelming consensus was that the Federal Reserve would lower interest rates Wednesday, most likely by 50 basis points. Of course, that's exactly what occurred. But most traders expected stocks to fall on the news, which didn't materialize with any substance -- at least not until Friday's session, when the Dow Jones Industrial Average fell 1.1%, the S&P 500 shed 1.8% and the Nasdaq Composite lost 4.4%.

Friday's setback assured negative results for broader market averages after a week of relatively modest moves. Snapping a string of weekly advances at three, the S&P fell 0.4% for the period and the Comp shed 4.3%.

But the Dow rose 1.9% for the week behind strength in interest rate and economically sensitive components such as Aloca AA, International Paper IP and Procter & Gamble PG. Overall, gains by consumer-focused names, financials and commodity producers reflected the growing view that Fed rate cuts to date, and more to come, will revive the economy, which flashed more signs of weakness this week.

Tuesday's consumer confidence report, Wednesday's fourth-quarter GDP figures and Thursday's NAPM report were the latest indicators reflecting a contracting economy. Friday's employment report cast some doubt on that trend, however, as nonfarm payroll growth in January far exceeded expectations. Then again, the unemployment rate rose to 4.2% from 4%, outstripping projections.

In Wall Street's seemingly counterintuitive mindset, "bad" news on the economy is "good" because it heightens the likelihood for more rate cuts. Indeed, the combination of the GDP and NAPM data along with the strong language in the Fed's statement had many on Wall Street convinced the Fed would ease prior to its next scheduled meeting on March 20. But Friday's employment data rattled such expectations. Indeed, concern that the Fed might not ease as aggressively going forward as previously assumed was cited as a factor in Friday's weakness in both stock and bond prices.

"While the payroll data was no doubt distorted by seasonal adjustment problems, it will no doubt impact expectations for an intermeeting rate cut and will almost certainly eliminate any chance for a rate cut in February," Tony Crescenzi, chief bond strategist at Miller Tabak, wrote on BondTalk.com Friday. "In fact, there is a chance that the March rate cut might be just 25 basis points and not the 50 the market expects."

But from the point of view of most equity market participants, Friday's weakness merely reflected an overdue setback after general strength thus far in 2001.

The Fed "cut a full basis point in a month and apparently that is not enough for a lot of people," said Michael Driscoll, director of listed trading at Credit Suisse First Boston, on Friday afternoon. "I think the market is handling it pretty well despite today's selloff. The gloom that's out there is certainly unwarranted."

Driscoll reiterated the time-honored mantra about the folly of combating the Fed. Portfolio managers sitting on cash and other investors similarly positioned will ultimately "be forced to chase performance and will never catch up," the trader said. "Every time people are waiting for something to happen -- it won't. The money on the sideline is waiting for an opportunity and it's not going to happen."

Reflecting on the recent action, Driscoll was impressed at the market's continued "resilience to bad news," be it on the economic front or from specific companies.

Shareholders of companies whose stock was battered in recent days by either outright earning disappointments or warnings, or other negative developments -- including InfoSpace INSP, PMC Sierra PMCS, AOL-Time Warner AOL, Adobe Systems ADBE and lesser-known names such as Professional Detailing PDII and Computer Network Technology CMNT -- might argue otherwise.

Then again, cautious comments from tech bellwethers Cisco CSCO and Applied Materials AMAT early in the week didn't do much damage to the market's overall tone.

On the Other Hand

While most market watchers were sanguine about Friday's drop, others believe it is the beginning of the end of 2001's nascent rally.

"The Fed has had three cracks to influence failing psychology and so far it's failed," said Steve Hochberg, co-editor of The Elliott Wave Financial Forecast, a newsletter known for its skepticism.

After flirting with 11,000, the Dow closed at 10,864.10 on Friday. Hochberg noted that's below its close on Dec. 5, when the index rallied sharply following comments from Fed chairman Alan Greenspan indicating that rate cuts would be forthcoming.

The Nasdaq, meanwhile, peaked intraday on Jan. 24, at the onset of the so-called "Fibonacci turn window" that Hochberg predicted would occur at January's end. To recap, the turns are designed to identify when short-term changes will occur, not which direction the market will go -- the theory being that whichever direction the market is going heading into the turn date, it will reverse course thereafter.

The Nasdaq and Dow had "diverged pretty noticeably" this year, but Hochberg believes Friday's action signals they're back in sync and "that's about it for the upside."

The newsletter writer noted there is not another turn expected until late March, suggesting February could be "choppy" at best for those long. The Comp could retest its Jan. 2 lows and the Dow could break 10,000 in the coming weeks, he forecast.

Optimists can take solace knowing that most Wall Street observers believe any decline will be short-lived because the Fed is taking action and stocks have historically fared well when the Fed is easing. Whether history repeats itself and that faith will be rewarded remains, of course, to be seen. From this past week, it appears the faith is there but not so much the rewards.