Rate Cut Leads to Market Slide

11/05/2007 12:00 am EST

Focus: MARKETS

Joe Sunderman

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

Joseph Sunderman and Beth Gaston Moon of Schaeffer's Investment Research say the Fed's latest rate cut came amid mixed earnings, weak sentiment, and increasing volatility.

The Federal Open Market Committee celebrated Halloween by treating the markets to a 25-basis-point rate cut, which took the key interest rate to 4.5%.

Unfortunately, the central bank also tricked those hoping for continued cuts, noting that future rate reductions are far from guaranteed.

Near-term federal funds futures subsequently moved much lower by the day's conclusion, [but] falling stocks and more credit-crunch concerns sent fed-funds futures rallying once again on Thursday.

By Thursday's settlement, the December contract priced in a 60% chance of another 25-basis-point rate cut to 4.25%. This is up from a 44% chance priced at Wednesday's settlement.  The February contract fully prices in a move to 4.25% by the January 29-30, 2008 meeting.

The Dow Jones Industrial Average followed up Wednesday's triple-digit gain with a larger loss-try 363.4 points. All but one of the Dow's components finished the day in negative territory, and that was Microsoft, [which] crawled higher, much like a salmon swimming upstream.

[Meanwhile], optimism continued to wane among investment-newsletter editors this past week, as the bullish reading at Investors Intelligence dropped to 53.8% from 56.5%, hitting its lowest point since the week of September 10. The bearish reading, meanwhile, rose fractionally higher to 23.1%.

[Thursday's] sharp pullback in the broad market put some life back in the volatility indices: the CBOE Market Volatility Index (VIX) soared 25.3% to clamber back above its 10-day and 20-day moving averages, as well as support at the 20 level.

With the calendar turning to November, we're officially more than halfway through earnings season. [Of the] 61% of Standard & Poor's 500 companies [that] have already issued their reports, earnings are showing a 5.3% contraction from last year, the worst performance since the fourth quarter of 2001.

Thomson Financial, however, says earnings are down just 0.9% and only 22% have missed earnings estimates, just slightly [above] the average of 19% falling short in the past eight quarters.

Additionally, if earnings from the homebuilding and financial sectors are left out of the equation, S&P 500 earnings would show a rise of 13.1%, with eight of the ten major sectors showing growth of 8% or better.

For October, the best-performing industry groups (as noted by BigCharts.com) were Internet, coal, mining, and computer hardware issues, all of which posted double-digit percentage gains on a sector basis.

The worst performers for the month were mortgage-finance issues, clothing and accessories, specialty finance, and mobile telecommunications.

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