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Angry Wall St. Slams Stocks

Markets: Amid concern over size of Fed cut, key indexes dive. But analysts say the trend of credit-easing still should benefit shares longer term.


NEW YORK — Despite Wall Street's tantrum Tuesday, analysts say that Federal Reserve interest rate cuts historically have been powerful medicine for troubled stock markets. They just don't always work overnight.

And even when Fed cuts are helping stocks recover, other things can push the market down--for example, Iraq's 1990 invasion of Kuwait.

This time around, the Fed's credit-easing campaign comes as corporate earnings have fallen off a cliff amid the weaker economy. Wall Street analysts continue furiously marking down their profit estimates, to the point that some industry sectors aren't expected to show profit gains at all this year, while others seem unlikely to perk up until at least the third quarter.

What's more, the Japanese economy may be skidding toward recession, and European economic growth is slowing markedly--so the rest of the world can't take up America's slack.

In the face of such problems, stock-market players are complaining loudly that the Fed isn't cutting rates aggressively enough.

They registered their disappointment by sending the technology-heavy Nasdaq composite index down 93.74 points, or 4.8%, to 1,857.44, its lowest close since Nov. 13, 1998. The Dow Jones industrial average fell 238.35 points, or 2.4%, to 9,720.76, nearly a two-year low.

The market had been up before the Fed made its announcement about 2:15 p.m. EST. Many traders had all but talked themselves into a rate cut of three-quarters of a point.

When the Fed came through with a half-point cut, it was "like leaving a 4-foot putt short," ING Barings economist Lawrence Kudlow moaned on CNBC.

"A lot of guys who might have bought a little ahead [of the Fed announcement] got out afterward," said John O'Donoghue, co-head of listed trading at CS First Boston.

But with the Fed still clearly in credit-easing mode, the long-term outlook for stocks may be brighter, if history is any guide. Almost invariably, the market eventually responds favorably when the central bank is lowering rates.

As rates fall, the trend helps stocks in two classic ways: by reducing borrowing costs for companies, and by making alternatives to stocks--such as bank CDs--far less attractive to investors.

Since 1971, the Fed has undertaken 13 credit-easing cycles--that is, periods when it cut key interest rates two or more times in succession.

Every time, the Nasdaq composite index has shown a gain one year after the first rate cut; 12 out of 13 times, the Standard & Poor's 500 index also has advanced, according to S&P and Bloomberg News data.

And the gains have been lofty, averaging 27% for Nasdaq and nearly 19% for the S&P.

The market's performance in the six months after initial Fed cuts has been spottier but still impressive, on balance. Both Nasdaq and the S&P have been higher six months later in 10 of the 13 credit-easing cycles.

Though the market has slumped this year since the Fed made its first rate cut Jan. 3, analysts note that it's still early in the process.

In modern times, the market's weakest performance amid falling interest rates came after the Fed started easing in June 1989. One year into that slow, quarter-point-by-quarter-point campaign, Nasdaq was up only about 3% and the S&P about 13%.

What's more, after Iraq invaded Kuwait in August 1990 the market dived, heralding a U.S. recession.

That was the exception, however.

Edward F. Keon Jr., director of quantitative research at Prudential Securities, said the trend of market outperformance during Fed credit-loosening cycles goes back at least 50 years, although it used to be hard to know just when the Fed was changing policy because it didn't begin announcing its moves until 1994.

"The overriding message is that you want to be holding stocks when the Fed is on your side," Keon said.

But some market watchers worry that this time may be different.

John G. Lonski, chief economist of Moody's Investors Service, noted Tuesday that during the last Fed easing cycle, beginning in the fall of 1998, the U.S. economy was far stronger than it is today.

Amid the Asian financial crisis, U.S. retail sales fell to an annual growth rate of 4.2% in the third quarter of 1998 and business sales growth fell to 2.6%.

In the first quarter of this year, by contrast, retail sales are estimated to be growing at only a 3.3% annual rate and business sales at 1.6%, Lonski said.

If the market is accurately foretelling recession, there's a strong possibility that stocks will go lower before they rebound, even with the Fed on the market's side, analysts note.


How Stocks Fare When the Fed Cuts

Here is a look at the price changes of the Nasdaq composite index and the Standard & Poor's 500 index six months and

one year after the Fed began cutting rates in each of

13 credit-easing cycles since 1971:


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