January 31, 2008

US stocks stage rally after rate cut

Wall Street stocks enjoyed a rally on Wednesday after the Federal Reserve Open Market Committee cut the funds rate by 50 basis points to 3 per cent as traders had widely expected.

Stocks traded in negative territory for most of the morning after a disappointing report on economic growth but materials and industrial companies led a rebound after the FOMC decision.

The Fed's accompanying statement warned that financial markets remained "under considerable stress" amid "a deepening of the housing contraction as well as some softening in labour markets."

In mid-afternoon the S&P 500 was up 1.2 per cent at 1,379.80 having traded down 0.2 per cent prior to the Fed's announcement. The Nasdaq Composite put on 1 per cent to 2,382.07 while the Dow Jones Industrial Average gained 1.2 per cent to 12,633.21.

A cut of 50bp was almost universally expected with the futures market having priced in a 72 per cent likelihood of such a move. 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.

Further evidence of this contraction was provided by a report which showed the economy slowed sharply to a 0.6 per cent growth rate in the last three months of 2007, only half the rate forecast by economists and down from 4.9 per cent in the previous quarter. For all of 2007, the economy expanded at its slowest pace since 2002, growing just 2.2 per cent.

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.

"There are two possible interpretations of the job situation," said TJ Marta, strategist at RBC Capital Markets. "Either we are going to experience a 'joblessness' stall in growth, just as we experienced a jobless recovery, or the economy remains somewhat insulated from the continuing credit crisis - at least for now."

Financial stocks came under pressure after UBS, the Swiss bank, took $14bn in writedowns for the fourth quarter, $4bn more than previously advised. The writedown included a $2bn hit which analysts speculated was linked to troubled monoline bond insurers.

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 rose 1.4 per cent to $28.31 after the Fed decision, while Merrill gave up 0.8 per cent to $56.99 after its chief executive, John Thain, said the bank's net exposure to monoline insurers was $3.5bn.

Earnings news was led by Yahoo, which reported a 23 per cent decline in fourth quarter profit and gave a cautious outlook for 2008. The shares slumped 8.6 per per cent to $19.03 after several analysts downgraded.

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 7.9 per cent to $26.70. Pulte Homes, down 2.5 per cent at $14.47, was due with its earnings late yesterday.

Merck, 4.6 per cent weaker at $45.80, fell to a $1.63bn loss after it took a big charge to cover litigation costs. Also declaring a big charge was United Parcel Services, which took a $6.1bn pension-related hit. However, adjusted net income of $1.2bn came in line with expectations and its shares climbed 2.5 per cent to $72.66.

Boeing was the best performing Dow component after it increased fourth quarter earnings by 4 per cent and raised its 2008 profit outlook. Shares in Boeing climbed to $83.50.

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