October's rally rubber hit the road this week and mainly spun its wheels, but major averages managed to post their fourth consecutive weekly gains.
Thanks largely to Friday's gains, the
Dow Jones Industrial Average
ended the week up 0.9%, the
higher by 0.4% and the
by a relatively robust 2.2%.
The Nasdaq's outperformance was fueled, in part, by cautiously optimistic comments midweek from
CEO Sam Palmisano about the state of the global economy, better-than-feared earnings from
, as well as
forecast that it will return to profitability in 2003.
Skeptics took umbrage with each of those developments but demand for a host of tech names continued nevertheless, specifically for semiconductors and telecom. For the week, the Philadelphia Stock Exchange Semiconductor Index rose 7% while the Nasdaq Telecom Index gained 3.6%.
Myriad explanations were offered for sharp percentage gains posted by previously downtrodden names such as
, as well as ongoing demand for chip-equipment makers such as
bullish argument for tech's recent awakening is that the group is trading at relatively attractive valuations given the economy's recovery. Thursday's advance third-quarter GDP report showed a 6.5% rise in spending on software and equipment, contributing 0.5% to the 3.1% overall growth. Overall GDP was a bit lower than consensus but up from 1.3% in the second quarter.
Apparent signs of improving fundamentals, combined with fund managers' demand for higher beta -- or volatile -- stocks helped produce a self-reinforcing cycle as the rally proceeded: Fund managers still heavily weighted in tech sought to keep the momentum going to aid their own portfolios; short-selling holdouts were forced to cover; previously sidelined participants entered the fray. The Oct. 31 fiscal year-end for many funds also aided this process.
To skeptics, the recent action is merely a repeat of recent episodes that proved to be false bottoms, and proves that speculative juices flow unabated despite the vicious bear market. Several analysts opined that the recent tech-led rally is built on shaky foundations while valuations remain high compared to historic levels. Moreover, evidence of the economy's improvement remains spotty.
Excluding autos, third-quarter GDP rose just 1.5%, while Friday's employment report and Institute for Supply Management survey were both weaker than expected. Also this week, the Commerce Department said consumer spending fell 0.4% in September, the first decline since November 2001, while the Conference Board reported consumer confidence fell to its lowest level since 1993.
On Friday, the Economic Cycle Research Institute reported its U.S. weekly leading index fell to 118.3 for the week ended Oct. 25 from a revised 118.8 in the previous week. The index's six-month growth rate was flat at negative 3.4%.
Faith in the Fed
Another factor in this week's advance was the sharp rise in expectations of a rate cut at the
policy meeting on Nov. 6. Fed-funds futures settled Friday pricing in 100% odds of a 25 basis-point rate cut next Wednesday vs. under 10% late last week. In another indication of market expectations, the 2-year Treasury note ended the week yielding 1.74% vs. the current fed-funds target of 1.75%.
Optimists, whose ranks swelled the past two weeks, according to surveys by
and the American Association of Individual Investors, contend the potential for another Fed rate cut provides hope for the economy's future and a rationale for buying shares. Those supporting another rate cut next week say it's better for the Fed to act now rather than risk seeing the tenuous rebound falter.
Such sentiments were on display Friday when the
rose 1.4%, the
gained 1.7% and the
rallied 2.3% despite the ISM survey being at its lowest level since December 2001, and the modest decline in non-farm payrolls for a second straight month and vs. expectations for a slight rise. (Still, the unemployment rate at 5.7% was slightly lower than expectations and September's payroll decline was revised to 13,000 from 43,000 originally.)
To naysayers, there's the nagging fact that the Fed cut rates 11 times in 2001 and the fed-funds rate has been at a 40-year low for nearly a year now, to little positive effect for stocks. Furthermore, there's evidence that the low fed-funds rate already is helping those areas that are most likely to benefit from it, with little spill-over effects to other sectors. Most notably, auto and home sales remain strong, albeit down from peak levels.
This week, Dex Media was able to issue $975 million of high-yield debt in order to fund its leveraged buyout of
phone book unit. Meanwhile, investors put nearly $684 million into junk bond funds this week, the third straight week of inflows and the highest level in nine weeks, according to AMG Data. Furthermore, MZM money supply is growing at 9% annualized rate.
It's unclear why another 25 -- or even 50 -- basis points of easing will suddenly cure overcapacity in many areas, particularly telecom, or spark a sharp increase in business capital expenditures, when, to date, low fed funds have failed to do so.
Another somewhat overlooked development this week was the dollar's slide to a one-month low vs. the yen and two-month low vs. the euro, which reached parity with the greenback on Friday for the first time since late July. On Friday, the U.S. Dollar Index (cash) fell 0.57 to 106.07.
The dollar's dip could be a sign that currency traders fret a lower fed-funds rate will not really aid the economy, but could undermine foreigners' demand for dollar-denominated assets. Another rate cut could also unwittingly generate concern, as it would contradict the central bank's prior statements about the recovery as well as those from the Bush administration.
"Stabilization in U.S. stocks is crucial to preventing another fall in the dollar because so much is still riding on the hope of a U.S. economic recovery," wrote Jes Black, currency analyst at MG Financial Group. But "another rate cut by the Fed may not prevent a retest of this October's lows
which would undermine confidence in the U.S. recovery, raise questions about the Fed's effectiveness and drag the dollar below current levels."
Beyond the Fed's meeting, Tuesday's midterm election will hold a great influence over the market's near-term fate. Because of the market's momentum and seasonal factors, it seems likely the overriding trend will remain upward into year-end. But this week's action would seem to suggest the "easy money" has already been made.
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.