Expectations are funny, especially on Wall Street where they so often fail to match reality. Such was the case this week, as traders got almost everything they purportedly wanted but stock proxies failed to make any forward progress.
For the week, the
Dow Jones Industrial Average
rose a scant 0.2%, but the
shed 0.7% and the
Heading into the week, conventional wisdom held that the post-Oct. 9 rally would get a major secondary boost if the Republicans swept Tuesday's midterm elections and the
were to ease by a larger-than-expected 50 basis points on Wednesday. The odds of either seemed low early in the week, much less both.
Once again proving its limitations, the conventional wisdom proved incorrect about both the elections -- which saw Republicans expand their majority in the House and retake the Senate, and about the Fed, which did indeed lower the fed funds rates by 50 basis points to 1.25%. The prevailing mentality over what the market would do thereafter also proved incorrect.
Stocks rose Wednesday following confirmation of the Republican triumph and the Fed's aggressive rate cut, but the gains were relatively modest. That, in turn, led to a significant setback on Thursday and a modest decline on Friday when an early rally attempt failed.
To many observers, the proximate cause of Thursday's losses was a bleak fourth-quarter sales forecast by
, whose third-quarter results topped expectations. But there were multiple possibilities to explain stocks' lassitude, including:
The charts: To some, the stall was foretold by Monday's action, when big early gains spurred by a favorable ruling in Microsoft's antitrust case were halved by day's end. Microsoft couldn't surmount key resistance at around $57, perhaps a harbinger of the S&P's inability to hold above the 910 resistance level after trading as high as 924.58 intraday. (The S&P closed well above 910 on Tuesday and Wednesday but ended the week at 894.74 after falling 0.9% Friday.)
End of the Affair: Heading into Thursday's action, the Dow was up 20%, the S&P 18.9% and the Comp by 27% from their respective Oct. 9 closes. In the same time frame, the Philadelphia Stock Exchange Semiconductor Index jumped 54% and the Nasdaq Telecom Index leapt 43% with Tellabs and KLA-Tencor among the standouts. Perhaps the slide following the Republican sweep/Fed ease was a classic "buy the rumor, sell the news" trade.
Nothing Else Matters: On the other hand, some believe the rally from the Oct. 9 lows was fueled mainly by fund managers' desperation to salvage their fiscal years ending Oct. 31. Their buying in turn prompted short-covering by some and an equally frantic desire for delta -- or highly volatile names -- by other participants afraid of missing the rally.
Proponents of such a view note that most of the rally was concentrated in very speculative names, and argue all the talk about the elections and the Fed was just that, talk. In other words, the rally had nothing to do with fundamentals and thus neither did the relatively modest retreat Thursday and Friday. Believers in this theory contend another big rally push is coming before year-end, when bonuses and/or pink slips are distributed.
Trouble at the Top
The latter point has resonance, but it's hard to ignore this week's heavy slate of fundamental developments. This was truly a historic week, and not just because a Republican president's party gained seats in both congressional houses in a midterm election for the first time in 100 years. Or because the Fed lowered the fed funds rate to its lowest level since 1958. Or because the
Securities and Exchange Commission
chairman resigned. Or because of the United Nations resolution regarding Iraq on Friday.
This week also was historic because the election and the Fed meeting crystallized hopes that policymakers will not repeat the same mistakes of the post-1920s U.S. stock mania and post-1980s Japan stock and real estate bubble: Namely, overly restrictive monetary and fiscal/tax policies.
"Policymakers are now moving to re-energize the U.S. economy, and the results should be strongly evident by mid-2003," observed Richard Berner, chief U.S. economist at Morgan Stanley. "Fed officials have eased aggressively and probably won't reverse course until the recovery accelerates. And the new Congress likely will provide another dose of fiscal stimulus by next spring."
Berner (still) believes a so-called double-dip recession can be avoided, although that's not assured, and myriad challenges remain in the present postbubble environment. Still, hard-core bears now must at least reconsider their Depression-era/deflationary spiral economic scenarios.
Many deduced this week's ease will be the Fed's last of the cycle, but recent history suggests otherwise. Throughout 2002, the Fed described monetary policy as "accommodative" and as recently as June considered the economy's risks "balanced" between weakness and inflation (a bias it reinstated Wednesday). In July, Fed Chairman Alan Greenspan
told Congress the fundamentals are in place for a return to sustained, healthy growth."
Point being, the Fed -- and Greenspan -- have proven themselves to be quite fallible in recent years and quite willing to change their mind when the economic, stock market and (
) political winds dictate. Wednesday's larger-than-expected rate cut was another example of this truth, and perhaps investors' acknowledgement thereof also explains the market's late-week slump. Bottom line: Don't be so sure the Fed won't lower the fed funds rate again sometime in 2003.
While that's precisely what the Fed should do, there are consequences to its actions. The Fed's half-point cut was another signal of its attempt to discourage Americans from saving money -- despite the central bank's own report Thursday that consumer credit grew by $9.9 billion in September vs. $5.6 billion in August, which was revised from $4.2 billion originally.
In addition, the European Central Bank and Bank of England refused to follow the Fed's easing lead while the presumptive tax cuts and increased spending on homeland security from a Republican-controlled Congress will further increase the U.S. budget deficit.
All that served to undermine the value of the dollar, whose decline this week was further exacerbated by the heightened prospect of war with Iraq. The Dollar Index ended Friday at 104.52, just above its July 19 lows.
Given the greenback's performance, the U.S. stock and -- more noticeably -- U.S. Treasury market ended the week in relatively impressive fashion. Sustaining that dichotomy or reinvigorating the dollar will be the financial markets' crucial challenge in the weeks ahead.
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.