Main Street Pain Trumps Fed

Apple's results late Tuesday highlight concerns about consumer spending, even as the Fed cuts.
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On a day when the


extraordinary 75-basis-point rate cut could not inspire a positive day in the U.S. stock markets,


(AAPL) - Get Report

reminded investors that more pain is in store from the economic fallout of a national downturn in the housing market.

Apple, the king of gadgetry that has been a longtime Wall Street star for its ability to woo American consumers with iPods and iPhones, reported a 57% jump in first-quarter profits that blew away analysts' estimates. That said, its sales and earnings outlook for its second quarter was well

below expectations.

The company forecast a profit of 94 cents a share for the current quarter, far short of the $1.09 a share that analysts were expecting. Its revenue forecast also fell short, coming in around $6.8 billion, compared with the $6.99 billion analysts had predicted.

The disappointment underscored the painful reality that the 2008 outlook for U.S. consumer spending, the nation's main engine of economic growth, is getting bleaker, and there's probably little that the Federal Reserve or Congress can do about it. Apple shares were selling off more than 10% in after-hours trading following the report, after dropping 3.5% during the regular trading session.

Apple's decline came amid a selloff in the broader stock market. That decline inspired Fed Chairman Ben Bernanke to abandon his heretofore cautious approach to easing Fed policy as the likelihood of a U.S. recession increases.

Following a series of

selloffs in key overseas stock markets like China and India while the U.S. was on holiday on Monday, the Fed announced it was lowering its fed funds rate target to 3.5%, cutting rates by more than 50 basis points at once for the first time since 1982.

Bernanke made the surprise move with a regularly scheduled Fed meeting just a week away. But with stock markets in Asia reeling and recession fears spreading fast, the central bank started chopping early to prevent all-out panic from hitting U.S. shores. Meanwhile, Bernanke signaled to the market that he was only getting started.

In a statement released Tuesday, the Fed said it "will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."

Fed funds futures markets were recently pricing in a 74% chance that the Fed will cut rates again next week by 50 basis points. Meanwhile, the yield on the 10-year Treasury note was down 16 points to 3.48%, signaling that investors see rates going lower.

Major U.S. stock prices plunged early in the session, with the

S&P 500

down almost 3% at its low. The Fed inspired a rebound, but investors couldn't stop the bleeding. The

Dow Jones Industrial Average

and the

S&P 500

both finished down 1.1%, while the

Nasdaq Composite

lost 2%.

"What's most significant is that stocks did not close in the green, so this wasn't a clear all-systems-go rebound on the Fed's action," says Phillip Roth, chief technical market strategist with Miller Tabak & Co.

While Bernanke stemmed the tide with Tuesday's action, he also signaled to investors that previously his Fed was behind the curve on the risks facing the economy.

"First they were too slow to act, and then they kind of freaked out on Tuesday," says Woody Dorsey, president of Market Semiotics. "This Fed doesn't look very good, and we're now in a bear market. It's been coming for a while, but it really got going last week. We made a low on Tuesday, but it's not the low. There's more to come."

Despite the intense gloom before the Fed's action on Tuesday, some investors were looking for an opportunity to buy stocks into the selloff. Even while he predicted a U.S. recession, Banc of America Securities analyst Tom McManus said he was raising his exposure to equities in a note to clients late on Monday.

"With the S&P 500 down at least 10% vs. a year ago, it makes sense for investors to consider increasing their exposure to equities into the selloff, gingerly or aggressively, depending on their investment horizon," said McManus.

Retail analyst Colin McGranahan with Sanford C. Bernstein & Co. noted in a report that he expects "slowing consumer spending and deteriorating retail fundamentals over the next several quarters."

That said, he upgraded shares of housing-related retail stocks that have been pummeled lately, like

Home Depot

(HD) - Get Report



(LOW) - Get Report


Bed Bath & Beyond

(BBBY) - Get Report



(WSM) - Get Report



(KSS) - Get Report



(M) - Get Report

to outperform from market perform, citing their low valuations. All those stocks rallied at least 5% on the session.

"History suggests that now is the time to begin to build retail sector exposure," said McGranahan, adding that "we see limited downside risk in many retail stocks, with valuation multiples likely to expand significantly from low levels."

The contrarian report sparked a rare rally in retail, with the S&P Retail Index closing Tuesday up 5.3%.

Financials, the other dreaded sector of the housing downturn, also rallied.


(WB) - Get Report

climbed 3.6% while

Bank of America

(BAC) - Get Report

gained 3.9%. Both financial giants reported big drops in fourth-quarter earnings before the opening bell due to mortgage- and credit-related losses and writedowns.

Monoline insurers





(MBI) - Get Report

soared 28% and 46%, respectively, on speculation they could avoid more crippling downgrades from major ratings agencies. The bond insurers are trying to raise capital amid massive losses on mortgage-related writedowns.

Reporting a $3.3 billion fourth-quarter loss, Ambac's interim CEO Michael Callen said the company's liquidity position was "strong," but also noted the firm "is evaluating strategic alternatives with a number of potential parties."

Meanwhile, New York state's insurance regulator, which last month granted an expedited license for a new bond insurer owned by Warren Buffett's

Berkshire Hathaway


, said he was holding talks with "other parties about possible future capital investments" in troubled insurers.

James Bianco of Bianco Research says the optimism may prove short-lived, because he attributes problems throughout the economy to falling home prices. He says home prices will continue to fall in 2008.

"With this cut, the Fed saved the day, but they didn't save the markets for good," Bianco says. "As a matter of fact, this could come back and haunt them if stocks sell off again tomorrow or the next day. The Fed will cut again next week, but this kind of psychological lift gets harder to achieve the second time around."