The Coming Week: Street Awaits Prime Cut From Fed, Fears Unkind Cuts in Earnings Outlooks - TheStreet

The Coming Week: Street Awaits Prime Cut From Fed, Fears Unkind Cuts in Earnings Outlooks

The market isn't sure if the Fed will cut interest rates by 25 or 50 basis points. It's also getting used to reductions in earnings expectations.
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The question for the week is: How much deeper will the cuts go? And while it applies mainly to the interest-rate outlook, it will also apply to the next round of cuts in earnings projections.

After obsessing over earnings for the past several weeks, Wall Street this week turns its focus to the

Federal Reserve's policy meeting, where the direction of interest rates will be determined. But barring a one- or two-day reaction to the rate decision, strategists expect stocks to trade within a narrow range next week.

The

Federal Open Market Committee meets on June 26-27 to determine how much it will cut the

fed funds rate target, and the market seems to be about evenly split over whether it will cut a quarter or a half-point.

Meanwhile, second-quarter earnings confessions should continue to trickle in, but market pros say investors have developed a kind of immunity to announcements, particularly in tech. After several weeks of earnings warnings from high-profile companies, investors seem to have given up on a third-quarter acceleration in earnings, and hopes for the fourth quarter

are dimming.

"We think the big catalyst now is how people think about 2002 earnings, and we're not going to get a good feeling for that until September or October," said Tobias Levkovich, senior institutional U.S. equity market strategist at

Salomon Smith Barney

.

The only major piece of economic data to come out next week is the May

durable goods orders report, scheduled for release Tuesday. Earnings reports from networker

3Com

(COMS)

and handheld-appliance maker and 3Com spinoff

Palm

(PALM)

are scheduled for Tuesday, while foods giants

General Mills

(GIS) - Get Report

and

ConAgra

(CAG) - Get Report

report Wednesday and Thursday.

Fed Time

Just over a week ago, economists were pretty confident that the FOMC would lop off no more than a quarter-point this meeting, leaving rates at 3.75%. But some earnings warnings and a round of weak economic data since then have convinced some market watchers that the risk of recession is great enough to

warrant more, and the bond market is now pricing in 45% odds of a half-point cut.

Either way, investors now want hard-core and sustained evidence of a turnaround. In its most aggressive rate-cutting schedule of the past 19 years, the Fed has lowered interest rates five times since the beginning of the year, dropping them 2.5 percentage points to 4%, but those rate cuts haven't yet had much impact on the economy or earnings.

"The Fed has already done most of the rate cutting that it's going to do, and the market really wants to see results outside of the housing market," said Peter Boockvar, equity strategist at

Miller Tabak

, who expects the Fed to cut by a quarter-point Wednesday. So far, production and capital spending remain markedly weak, while economic conditions are worsening in Europe and Asia. And as the past few weeks of confessions have shown, plenty of tech and Old Economy companies are seeing continued slowing in earnings.

"If we get 50

basis points, there may be a knee-jerk rally that we've gotten in the past with rate cuts, but stocks will probably stay in a trading range until we see what the third quarter is going to look like, and that probably won't be for another month," said Boockvar.

Bruce Kasman, chief U.S. economist at

J.P. Morgan

, expects the Fed to cut rates by a half-point Wednesday, and thinks there may be even more to come after that, in August. "The economy is still very much at risk of falling into recession here," said Kasman. "While

Greenspan signaled in a recent speech that he wanted to slow the pace of easing, there have been no signs of strengthening in the economy," he said. If the Fed cuts by 50 basis points, Kasman thinks it will cut rates again when it meets on August 21. But if it cuts by just 25 basis points, he expects it to cut rates again between meetings.

May durable goods orders, considered a key factory sector indicator, could sway the Fed's plans for rates. Economists are expecting a major uptick in the indicator, which measures the value of orders received by manufacturers for goods like motor vehicles and appliances, to a 0.6% rise from a 5% drop in April. Durable goods orders tend to be volatile, but are a leading indicator, or predictor of future economic performance.

It's also possible that any major Nortel-sized

earnings surprises could dunk the market and influence the Fed. On June 15,

Nortel

(NT)

forecast a substantial second-quarter revenue shortfall, announced plans to cut another 10,000 jobs, and said it will record a charge of $12.3 billion for the writedown of intangible assets. While many heavy-hitters have already warned, there are plenty left that could

follow in Nortel's footsteps.

"There are still rumors about

Microsoft

(MSFT) - Get Report

and

IBM

(IBM) - Get Report

," said Levkovich. "There are always going to be rumors. We are never immune. We can always get killed again."

Still, strategists say the earnings picture is probably about as clear as it's going to get for at least a few months, and investors may punish individual stocks rather than the broader market when companies confess.

"I think they'll probably take individual stocks out and shoot them if they miss," said Levkovich.