Fed Drives Stocks Up, Fear Down

09/20/2007 12:00 am EST

Focus: MARKETS

Joe Sunderman

Vice President of Research and Development, Schaeffer's Investment Research

Joseph Sunderman of Schaeffer’s Investment Research looks at the impact of the Federal Reserve’s decision to cut interest rates and thinks it’s bullish for stocks globally.

Emerging from nearly six hours of deliberation at 2:15 pm Eastern time Tuesday, the Federal Open Market Committee matched dovish expectations, unanimously instituting an aggressive 50-basis-point cut in the federal-funds rate, [to 4.75%].

This was the first rate cut since Ben Bernanke took over as Federal Reserve Chairman, and it was the first cut overall since June 2003. The discount rate was also lowered by half a percentage point to 5.25%.

In the meticulously digested accompanying statement, the rate-setting board noted that Tuesday’s cut "was necessary to forestall some of the adverse effects on the broad economy that might otherwise arise from the disruptions in financial markets."

Seconds after the Fed's rate announcement hit the Street, every stock, index, and exchange-traded fund on my tracking screen was snugly in positive territory—everything, that is, except for the volatility indices, which serve as fear barometers and therefore tend to retreat in the face of advancing stocks.

The CBOE Market Volatility Index (VIX) dropped 23% Tuesday—the largest one-day VIX decline since its 25.9% dive on June 15, 2006.

Overseas markets were broadly higher [in response], with ten of the 11 indices we track firmly in positive territory. The average return on the group stands at a healthy 2.481%, with China's Shanghai Composite the lone decliner after posting record-closing highs during the last two sessions. The Hong Kong Hang Seng index stole Shanghai's thunder to close at its own record high after the Hong Kong Monetary Authority cut interest rates by half percentage point to 6.25% before the start of Wednesday's session.

In Japan, the central bank decided to hold its own interest rates steady at 0.5% (the lowest in the developed world). The Nikkei 225 turned in its biggest point gain in more than five years as exporters and financial issues rocketed higher.

European markets cheered the US Fed's decision to cut interest rates by 50 basis points, with banking and financial issues posting the largest gains after better-than-expected earnings results from Lehman Brothers.

Metals prices soared in the wake of the rate cut (the StreetTRACKS Gold Trust—GLD—rose 1.03% as gold inched lower in regular-session trading), and shares of construction and homebuilding companies rallied as subprime fears eased. However, UK mortgage lender Northern Rock slipped lower as rumors swirled of a low buyout bid. At last check, the UK FTSE 100, the German DAX, and the French CAC 40 are all hovering around 145-point gains.

Despite Tuesday's strong rally, data supports a bullish bias in weeks to come. Also, given such a surprise in the size of federal-funds rate cut, this could help provide a positive backdrop as we head into the stronger parts of the year–the fourth quarter.

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