January 31, 2008

Dow's rally proves shortlived

A brief rally by US stocks fizzled out in late trading yesterday after a 50 basis point rate cut by the Federal Reserve Open Market Committee failed to convince traders the US economy is on the mend.
Financial companies led a rebound immediately after the Fed cut the funds rate to 3 per cent but traders then took profits as rumours began circulating of more potential downgrades at key bond insurers.

A 50bp cut was almost universally expected and analysts said that although there was considerable downside potential if the Fed had not satisfied the market, the upside from its more aggressive stance was limited.

"People are selling any kind of rally they can get and lock in any profits they can," Ryan Larson, senior equity trader at Voyageur Asset Management, said. "Anyone who things these problems are going to disappear with a single cut has more thinking to do."

The S&P 500 closed down 0.5 per cent at 1,355.81 near its lows for the session, having earlier soared 1.7 per cent immediately after the Fed eased. Of the S&P's ten leading sector only industrials and technology ended in positive territory with telecoms and financials weakest.

The Nasdaq Composite gave up 0.4 per cent to 2,349 while the Dow Jones Industrial Average shed 0.3 per cent to 12,442.83.

"It's not a catalyst for an immediate rebound in the economy by any means. If the Fed hadn't delivered we would have been looking at a lot more red numbers," Hugh Whelan, equity manager at Hartford Investment Management, said.

The Fed has now cut interest rates by 125bp in little more than a week responding to concerns that the US economy is slowing rapidly.

"This removes the fear that things are going to get horribly bad. I think they did what they had to do and it takes that worse case scenario off the table," Bill Stone, chief investment strategist for PNC Wealth Management, said.

Further evidence of the problems the Fed is trying to tackle was provided by a report which showed the economy barely grew in last three months of 2007. For all of 2007, the US economy expanded at its slowest pace since 2002, just 2.2 per cent.

The news was a blow for those equity investors who have tentatively become more optimistic in recent days about growth prospects for US companies.

"The new leg down in housing, along with the continuation of the retrenching trend by the US consumer, is weighing on growth," said TJ Marta, strategist at RBC Capital Markets. "The Fed has a growth problem and a financial crisis to deal with."

However, a snapshot of private sector employment painted a contrasting picture, as a projection of hiring in January by ADP showed a rise of 130,000 jobs.

Although ADP numbers can be volatile, economists now expect the closely watched January employment report, due on Friday, to show a gain of 65,000, up from 18,000 in December.

The S&P financial index rallied 4 per cent off its session-low after the Fed cut rates but the sector closed in negative territory after Fitch Ratings cut bond insurer FGIC's triple-A rating to double-A. Ambac Financial and MBIA fell 15.9 per cent to $10.87 and 12.6 per cent to $13.96 respectively on fears they face downgrades from either Moody's or S&P.

Oppenheimer analyst Meredith Whitney said banks may have to write down up to $70bn if bond insurers lose their AAA credit ratings, with losses concentrated at Citigroup, Merrill Lynch and UBS.

"This is significant, as many investors are of the belief that the fourth quarter was a 'kitchen sink' for all outstanding capital hits this credit cycle," Ms Whitney said. "When it becomes clear [as we think it will] that more charges are on the horizon, we believe the market will take another turn for the worse."

Citi fell 0.1 per to $27.87 while Merrill gave up 2.4 per cent to $56.08 after its chief executive, John Thain, said the bank's net exposure to monoline insurers was $3.5bn.

In the technology sector Yahoo reported a 23 per cent decline in fourth quarter profit and gave a cautious outlook for 2008. The shares slumped 8.5 per per cent to $19.05 after several analysts downgraded the stock.

After the closing bell Amazon.com said its fourth quarter profit more than doubled to $207m, in line with expectations, but the shares, which closed up 0.4 per cent at $74.21, fell 8.3 per cent after-hours.

Rambus, the chipmaker, fared much better, soaring 17.7 per cent to $19.44 on hopes it could claim $10bn in royalties by winning a patent infringement case.

The recent rebound in US homebuilder stocks came to an end after Centex, the number four US firm, saw its fiscal third-quarter loss widen to $975.2m, much worse than analysts had feared. The shares fell 8.9 per cent to $26.41.

Merck, 3.2 per cent weaker at $46.47, fell to a $1.63bn loss after it took a big charge to cover litigation costs. Although adjusted earnings beat expectations, analysts were disappointed by sales of a cervical cancer vaccine.

Boeing was the best performing Dow component after it increased fourth quarter earnings by 4 per cent and raised its 2008 profit outlook. The shares climbed 2.3 per cent to $82.84.

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