Market Decides Not to Worry, Be (Fairly) Happy

A session highlighted by

indecision at midday morphed into one of cautious optimism. With the outcome of the midterm elections, Wednesday's

Federal Reserve

meeting and

Cisco's

(CSCO) - Get Report

earnings still unknown, market participants were understandably reluctant to take major bets, but major averages all ended higher.

The

Dow Jones Industrial Average

rose 1.2%, to 8678.27, while the

S&P 500

gained 0.8%, to 915.39, and the

Nasdaq Composite

rose 0.3%, to 1401.20. All three averages closed at their highest levels since August.

The Dow got its biggest boost from

Boeing

(BA) - Get Report

and

Procter & Gamble

(PG) - Get Report

.

Market breadth was essentially even, although slightly weighted toward declining stocks, while volume of 1.3 billion shares in

NYSE

trading and 1.5 billion in Nasdaq activity was down sharply from the prior day.

Monday's volatile session defied those expectations, but the action Tuesday was the kind of mainly directionless trading many participants expected this week, at least until after Wednesday's Fed meeting.

Down to the Wire

Last week, many traders were increasing their long positions on the hope of a favorable ruling in

Microsoft's

(MSFT) - Get Report

antitrust case, which arrived Friday afternoon; a Republican sweep in Tuesday's midterm elections; and a rate cut by the Fed.

The Microsoft news has come and gone and prospects for a Republican sweep in the election seem less likely. Although multiple races remain too close to call, influential pollster John Zogby has been quoted as saying Democrats will maintain a slim majority in the Senate. Elsewhere, the Iowa Electronic Stock Market is currently pricing in 58% odds that the status quo -- Republican House, Democratic Senate -- will be maintained, up about 15 percentage points from late last week and vs. just under 30% odds for a Republican sweep.

Meanwhile, the fed funds futures are pricing in 100% odds of a rate cut Wednesday, but Steve Beckner, an influential Fed watcher at

Market News

, published a story early Tuesday, indicating a 50-basis-point cut is unlikely.

Thus, it appears Wall Street is not going to get all that it apparently wants, meaning a

Republican sweep and a 50-basis-point rate cut.

One bond trader, who requested anonymity, said a 25-basis-point rate cut is "baked into the cake" for Wednesday's

Federal Open Market Committee

meeting but suggested the odds of a 50-basis-point ease are higher than currently forecast.

"If the Fed eases

aggressively now and the economy tanks, they can keep the finger of blame from being pointed at them," he said.

Additionally, the notion the Fed is handcuffed as the fed fund target rates approaches zero is mistaken, the trader said, citing the following from a recent op-ed piece in

The Wall Street Journal

by former Fed governor Wayne Angell:

"The good news is that monetary policy never runs out of power. The Federal Reserve does not face any rules that limit it from purchasing enough T-bills to add to high-powered money in the banking system, no matter how low interest rates decline. More liquidity eventually fills up the preference for investors to hold short-term money market accounts and CDs. In the absence of pricing power, and thereby an absence of inflation risks, both bond prices and equity prices would benefit."

The trader also took a somewhat unconventional view of the recent weakness in the dollar, which fell to a 3.5 month low vs. the euro early Tuesday and a one-month low vs. the yen before steadily climbing throughout the session. Following a similar pattern, the Dollar Index closed off 0.32, to 105.80, but above its early lows below 105.50, its lows since late July. His contention is that the Fed's presumptive ease Wednesday is going to be followed by similar moves from the European Central Bank (ECB) and Bank of England on Thursday, which will put downward pressure on the euro and sterling vs. the greenback.

Lisa Finstrom, senior currency analyst at Salomon Smith Barney, largely agreed, noting the futures markets are pricing in higher odds of an ECB rate cut that is what most economists forecast and ECB officials have hinted at.

"I'm not sure a coordinated ease is quite being reflected in the market right now," Finstrom said, suggesting the euro's intraday peak today of $1.0044 probably represents the top of the currency's trading range.

"Our bias is the dollar will stabilize here and rebound a bit," she said, adding a disclaimer that there's uncertainty about what kind of message the Fed will send about future monetary policy.

Furthermore, "I think what has to be seen is whether financial markets feel Thursday afternoon whether monetary policy conditions have been shifted to clear the stage for

global recovery," Finstrom said, noting ongoing concerns about profit growth and war with Iraq, while recent economic data have been "quite soft."

On Tuesday, the Institute for Supply Management's U.S. non-manufacturing survey came in at 53.1, which was higher than expectations but still down from 53.9 in September. Meanwhile, a survey of business sentiment in the Eurozone rose in October to 50.1, indicating slight expansion.

Notes and Notables

Other issues restraining traders Tuesday included reports in

The Washington Post

that both Iraq and North Korea have supplies of smallpox that could be used in weapons. The report was giving pause to some of Wall Street's prior zeal for war with Iraq.

Making headlines outside the geopolitical realm were a profit warning by

Circuit City

(CC) - Get Report

, which fell 13.2%; layoffs at

Applied Materials

(AMAT) - Get Report

, which lost 3.9%; a Federal Trade Commission subpoena against

Tenet Healthcare

(THC) - Get Report

, down 2.9%; and a 4.4% decline in

AmeriSourceBergen

(ABC) - Get Report

, which bested analyst expectations for its fiscal fourth quarter but lowered its forecast range for fiscal 2003 earnings.

Meanwhile, a number of sell-side analysts downgraded stocks Tuesday morning, citing valuation concerns, including:

Paychex

(PAYX) - Get Report

,

PMC Sierra

(PMCS)

American Express

(AXP) - Get Report

,

Automatic Data Processing

(ADP) - Get Report

,

Yahoo!

(YHOO)

,

Nextel

(NXTL)

and

Tellabs

(TLAB)

.

All of those names were down Tuesday, save Yahoo!, but that was after posting gains of between 24% and 81% from Oct. 9 through Monday's close. Some of the aforementioned had posted even more impressive gains from the July lows, most notably Nextel, up 367% since July 2.

Despite all those negatives and potential reasons to hold back from buying, stock proxies did close higher Tuesday, reflecting investors' fear of missing additional rallies rather than of losing recent gains.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.