The Coming Week: Nasdaq Keeps Rolling Ahead of Expected Fed Cut

The second week of earnings season should be a good test to see if the index's rally has been for real.
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For a second straight week, the Nasdaq managed to celebrate mediocre earnings reports while investors bet that the Federal Reserve will cut interest rates by another half-point at the end of the month.

Maybe it'll do it again in the coming week. But if Friday's session is any indication -- the Comp closed the day with a measly 1.9-point gain -- it may not. Some say the market may drift through this week on an absence of major economic news and ahead of that crucial Fed meeting.

The winds have definitely shifted in favor of the Nasdaq. So far this year, new highs have exceeded new lows on the index on every trading day -- sometimes by ratios as steep as 325 to 30. All this good news has come despite a general underperformance in fourth-quarter tech earnings, which had already been sharply ratcheted down in the past few months. The 175 tech companies that have reported earnings this quarter have missed consensus forecasts by an average of 5.5%, said Joseph Kalinowski, equity strategist at earnings tracker

I/B/E/S

.

It seems Wall Street is already investing in anticipation of a turnaround in the economy -- driven by aggressive Fed rate cuts -- six months down the line. The Nasdaq's action has certainly been encouraging, as it rallied heartily on Wednesday and Thursday despite pretty nasty economic data and some unimpressive earnings reports from major tech bellwethers.

"It seems to me the market is looking over the valley. That it is building in some aggressive Fed action, bracing for ugly economic news in coming months," said Jim Glassman, U.S. economist at

J.P. Morgan

.

Week's Weak Finish

But conviction was lacking at week's end. It's not that investors had changed their minds, and were now preparing for recession. Defensives like consumer staples are usually safe havens in time of recession and these stocks were down all week.

But some pundits were worried about the tech sector's inability to haul anything up with it. For most of the week, tech stocks rallied at the behest of pretty much everything else in the market.

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If investors really are convinced that a turnaround is in the cards, why haven't other cyclical stocks -- like industrial machinery makers -- joined in? After all, cyclical stocks tend to benefit from a pickup in the economy just as much as tech stocks do. Has the market just been using the rate cuts as an excuse to back up its greed for tech stocks?

"I'd say the rate of increase is probably going to flatten out," said Howard Barlow, vice president of

WHB/Wolverine Asset Management

. On Wednesday and Thursday, the Nasdaq rallied 3.6% and 4.4%, respectively.

Both the data and earnings rosters slim down a little bit in the coming week, and it's unlikely that the major force driving the market right now -- expectations of a half-point rate cut -- will change.

"It's hard to imagine how the coming week's

economic news is going to change

the interest rate picture. The durable goods news is important, but even if you see a change in capital goods spending, it's already a very weak quarter," said Glassman. December durable goods orders come out on Friday and are forecast to show a pretty drastic slowdown in the value of orders received by manufacturers for long-lasting items. Economists polled by

Reuters

expect growth in durables to fall to 1.3% from 2.3%.

Dogpile on the Rabbit!

In the past two weeks, data indicating the economy is rapidly deteriorating have accumulated. Last Thursday, the

Philadelphia Fed Index

fell to -36.8, its lowest level since December 1990, when the country was in recession. And Friday,

a preliminary read on the

University of Michigan's

Consumer Sentiment Index

came in at 93.4, its lowest level since 1996 and five points below the December level. Economists had expected the index to come in at 99.

Glassman said the tone in the financial market is more critical than any of these numbers to the Fed, while the highlight of the week is a speech by

Alan Greenspan on Thursday.

"The market is now priced for a 50 basis-point cut at the meeting, so anything he says will be weighed against that expectation. But all of

the Fed governors have been saying if necessary we'll be taking forceful actions to

revive the economy."

Friday, Richmond Fed President Al Broaddus -- typically very hawkish on the economy --

reiterated previous statements to that effect, saying the Fed would respond "decisively" to keep the economy from slowing "excessively."

Meanwhile, there aren't any tech bellwethers with the stature of

IBM

(IBM) - Get Report

,

Microsoft

(MSFT) - Get Report

or

Intel

(INTC) - Get Report

reporting next week.

Plenty of smaller tech leaders do report and could swing the market -- particularly if they make announcements about what kind of capital spending they are planning.

I/B/E/S' Kalinowski recommended looking for news of increased capital spending from companies such as

PMC-Sierra

(PMCS)

,

Qualcomm

(QCOM) - Get Report

and

JDS Uniphase

(JDSU)

. He also mentioned networker

Network Associates

(NETA)

and data storage firm

Veritas Software

(VRTS) - Get Report

.

Increases in capital spending reflect confidence in the future of the economy and the company's business, and if the market's outlook remains solidly on the horizon, that's exactly what they want to see.

Last week, chipmaking powerhouse

Intel

(INTC) - Get Report

reported OK earnings -- beating estimates by a penny but guiding lower for coming quarters. But plans to increase capital spending by $7.5 billion -- despite some incredulity -- sent the stock storming higher the next day.

One of the most frequent contestants in the earnings-warning game,

Lucent

,

(LU)

also reports earnings next week, but probably won't unleash any surprises. Lucent has issued so many earnings warnings in the past months that it's unlikely investors -- or the stock price -- has any more room for disappointment.

But it is earnings season, after all, and there always seems to be a little more room for disappointments.