The Fed Faithful Still Believe in Greenspan's Healing Powers

SAN FRANCISCO -- If nothing else, give investors credit for consistency. Despite little clear evidence of improvement after six rate cuts, market participants still cling to their faith in the Federal Reserve's healing powers.

Anticipation of more Fed easing tomorrow was the main impetus for today's market action, which saw the Dow Jones Industrial Average rise 0.8%, the S&P 500 gain 0.8% and the Nasdaq Composite climb 0.8%. Meanwhile, the dollar rallied but Treasuries faltered. In sum, today's activity amounted to a reflexive reaction to last week's developments.

As per usual, myriad theories abound regarding what the Federal Open Market Committee may do tomorrow. Some expect the Fed will provide the market with another jolt of shock therapy by lowering rates 50 basis points (or more). Others surmise the most prudent course would be for the Fed to do nothing and hope traders take inaction as a sign of the Fed's confidence in the economy's presumptive recovery. (Today, the Conference Board reported its index of leading economic indicators rose 0.3% in July, the fourth-straight monthly gain. But few traders believe the economy has bottomed.)

Ironically, both the "over" and "under" arguments have some appeal. But as with (legal) wagering on sports, the best bet when dealing with the Fed is to pay heed to the oddsmakers, in this case the fed funds futures market. Heading into tomorrow's FOMC meeting, the fed funds futures are laying 100% odds the Fed will ease by at least 25 basis points and just 10% odds of a 50 basis-point move.

If only because of the futures market's penchant for correctly forecasting (or directing, depending on your perspective) Fed action, a 25 basis-point rate cut is thus the most likely outcome tomorrow.

Fed funds futures also are predicting a 68% chance of another 25 basis-point ease by the Fed's Oct. 2 meeting, which means it's very likely the Fed will maintain what amounts to an easing bias.

Some may take solace in the notion that Alan Greenspan & Co. remain ever ready to cut rates beyond tomorrow's meeting. But Thomas McManus, equity portfolio strategist at Banc of America Securities, is not among them.

Back in January, you'll recall, McManus theorized that the time to get bullish is at the end of Fed easing cycles, not the beginning. The second half of that theory has clearly proved prescient, as anyone who got overly optimistic after the Fed's initial rate cut on Jan. 3 learned.

In a report today, he returned to this theme, writing "we remain especially concerned about the prospects for the [equities], given the risk that the Fed easing continues for awhile longer."

McManus, who expects a 25 basis-point cut tomorrow, sees the September-October time frame as "particularly troublesome." Rather than evoking the market's historic troubles in those months, he noted that market participants are "still anticipating an imminent upturn in profit measures."

The consensus estimate for S&P 500 earnings is for $12.25 per share in the third quarter (vs. $14.54 a year ago) and $12.95 in the fourth quarter (vs. $13.67), according to First Call/Thomson Financial.

"It is still too early to narrow down the likely fourth-quarter earnings growth," First Call's Chuck Hill commented Friday. But the earliest earnings could rise on a "seasonally adjusted sequential quarter basis" is first quarter 2002, he predicted.

"Fish or cut bait time on whether the earnings recovery will get underway in first-quarter 2002 will likely come in late September or early October," Hill wrote.

Hill didn't offer a prediction on the outcome. But, as he has long felt, McManus believes the estimates are too optimistic and frets stocks will suffer when they are ultimately revised lower.

Speaking of Tenacity...

Don Hays, of Hays Advisory in Nashville, Tenn., returned from vacation today. But rather than rescind his recent rally calls in the face of last week's big losses, the veteran market watcher redoubled the optimism.

"Conditions still look extremely favorable for current investments," Hays wrote this morning. Additionally, "with the intense pessimism that has been exhibited in the last nine months, I wouldn't be totally surprised if my expectation for another pullback next year has to be revisited for a more bullish posture."

Hays tabled that possibility for another day. As for the current environment, he noted each of the following developments from Friday as supportive of his steadfast bullishness:

The one-day Arms Index hit 2.52, pushing the 10-day reading to 1.661 vs. a peak of 1.657 near the Dow's March low.

The equity-only put/call ratio hit 0.9617, or just below its March high of 0.9726.

The Chicago Board Options Exchange total put/call ratio hit 1.071 compared with its March high of 1.076.

On the New York Stock Exchange, 58 stocks made new lows on Friday vs. 258 on March 22. In Nasdaq trading, 133 stocks made new lows vs. 569 on April 3.

The point being: The market's underlying strength -- evident by the new high/low levels -- has improved since the late March-early April lows, but key sentiment indicators have not. To Hays, that's an indication the "panic" is overdone and a rally is in the offing.

Then again, he's been saying that for a while now. But as noted above, consistency is today's theme.

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