Updated from 1:35 p.m. EST
Wall Street entered earnings season with too much optimism and suffered for its exuberance Wednesday -- although not as much as some expected.
A strong rally in the first two weeks of January was bolstered both by expectations of strong earnings and hopes that the
will soon step aside, as the economy seems poised to slow. Plus, there are no immediate worrying signs of inflation in official figures, as confirmed again Wednesday by the CPI data.
It therefore seemed safe to assume, as Wall Street has since December, that the Fed will indeed engineer a "soft landing" for the economy.
But the bulls hadn't factored in a less-than-perfect profit picture, even after last week, when
missed expectations and
issued a profit warning.
Eternal optimists therefore received a rude awakening after the close Tuesday in the form of misses from tech leaders
. Intel fell 11.5% on five times its average daily volume of the past three months while Yahoo! slumped 12.3% on nearly six times its average volume.
Selling pressure was intense overnight -- especially as Japan's Nikkei suffered another sharp correction -- and early Wednesday. But fears of a major pullback proved erroneous. The tech-heavy
fell to a morning low of 2264 but recouped much of the losses to close down 1% at 2279.
Still, after rallying nearly 6% in January through last Wednesday's close, the Nasdaq's gains have now been cut to roughly 3.4%. More weakness can be expected early Thursday as
TICKER TYPE="EQUITY" SYMBOL="EBAY" EXCHANGE="Nasdaq" PRIMARY="NO"/> joined the ranks of disappointing tech earnings and guidance. Apple was recently down 5%, and eBay down 4.7% in after-hours trading.
fell 0.4% to 1277, off a morning low of 1273. The
Dow Jones Industrial Average
lost 41.46 points, or 0.4%, to 10,854, off its morning low of 10,827.
Wednesday's weakness follows some selling pressure near the end of last week, which continued Tuesday as geopolitical tensions over Iran and Nigeria revived oil prices. Crude oil prices, which hovered around $66 per barrel for most the session, finished lower, helping stocks recover some ground. Crude futures finished down 52 cents at $65.79.
For a permabull like Al Goldman, chief market strategist at AG Edwards, this has been a "healthy" correction for the market, and it's already time to step back in and pick up the pieces. "The bell doesn't ring when you reach a low," he says.
Besides Intel and Yahoo!, jitters over Iran, Nigeria, and the selloff in the Japanese market have led to some "panic dumping" of shares, he says, typically a good time to be a buyer.
Goldman does expect the Fed to soon stop raising rates, believing this will help propel earnings to another year of double-digit growth in 2006.
Given that this has been the dream scenario of bulls, it might be wise to consider alternative scenarios, especially if more high-profile earnings disappointments start trickling through, as delivered by Apple and eBay after the close.
As mentioned by Wells Fargo senior economist Scott Anderson, equity markets have pictured themselves "in that bliss period when the Fed takes its foot off the brake and the economy continues to coast along like nothing has happened."
Certainly, the December consumer price index, released Wednesday, seemed to confirm the scenario of tame inflation. Led by lower gasoline and natural gas prices, the CPI unexpectedly fell 0.1% in December, instead of the 0.2% rise economists expected. Excluding food and energy, the CPI rose 0.2%, as expected.
A large part of the reason why core inflation was held down in December was a drop in auto prices. A steep drop in auto sales, and therefore consumption, is also expected to have pressured fourth-quarter economic growth. Wells Fargo expects GDP growth to have slipped below 3.0% from 4.1% in the third quarter. Others, such as Merrill Lynch, expect growth to have slipped to 2%.
But Wednesday, the Fed's "beige book," which surveys economic activity in the central bank's 12 regional districts, said that "economic expansion" continued in December and that labor markets "tightened," even if wage increases remained moderate.
Richmond Fed president Jeffrey Lacker, who votes on interest rates decisions this year, also sounded hawkish during a speech. The housing market has experienced "only a limited pullback" and given continued price pressures, including from energy, it is "too soon for Champagne," Lacker said, according to
That was enough to reverse previous optimism about the CPI in the bond market. The benchmark 10-year note fell 2/32 in price while its yield, which moves inversely, rose to 4.34%.
The yield of a three-month Treasury, at 4.35%, remained above that of the 10-year bond. When short-term yields top long-term ones, many economists believe an economic slowdown -- or worse -- is in the cards 12 months later. But Lacker said concerns about the yield curve inversion have been "overblown".
The idea, supported by incoming Fed Chairman Ben Bernanke, that long bonds remain a favored destination of foreign savings, was bolstered Wednesday by the latest Treasury report on international capital flows. Net foreign purchases of U.S. assets came in at $89.1 billion in November, down from $104.2 billion in October, still a record but down from the originally reported $106.8 billion.
"Overall, the data were plain vanilla, with no apparent trend changes in the pace of buying in the major asset categories," according to Miller Tabak. "That said, it will be comforting to some to see that both China and Japan were net buyers of Treasuries during November following net sales in October."
Unfortunately, for those hopeful for a gentler Fed, this global liquidity finding its way in U.S. stocks and bonds is further evidence of continued easy money conditions.
As mentioned by Goldman Sachs last week, the recent rally in equities -- the S&P 500 was up 10% from the October lows through Wednesday of last week -- would be evidence enough for the Fed that liquidity remains aplenty in the financial system and might lead the Fed to tighten further than expected.
And it's not just in the U.S. According to BMO chief economist David Watt, very high levels of liquidity also explain why global equity markets have performed well in January. That's also pressuring the Bank of Japan and the European Central Bank to raise the cost of money by lifting rates (the ECB has already begun in December).
"For the Fed, the problem of too much money slushing around in the system is compounded by the fact that there's little slack left in the (U.S.) economy," Watt says.
On Tuesday, the Fed did report a solid 0.6% gain in industrial production in December. Capacity utilization, which measures slack in the economy, rose to a five-year high of 80.7%, it said.
After riding high on expectations of strong earnings and of a gentler Fed, Wall Street might therefore be whipsawed around for a while.
Evidence that the economy, and perhaps earnings, slowed in the last quarter of 2005 doesn't preclude a rebound in coming quarters. That scenario, together with low bond yields and/or bullish stock markets, might keep the Fed raising for longer than currently expected.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;
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