Fed fights against recession

THE STOCKS in the S&P 500 Index capped their best week in 14 years, propelled in large part by a surprise interest rate cut by the Federal Reserve as it works to keep the US economy growing.

More gains could come, if history is any guide. The Fed's move on Thursday resembles its decision to lower interest rates in December 1991, after which "the market went straight up", said Laszlo Birinyi, president of Birinyi Associates, a money management firm in Connecticut. US stocks rallied in eight of the 10 days following that cut, and the market was on its way for the great bull run of the 1990s.

For the week, the Dow Jones Index jumped 6.5 per cent, its biggest gain in 13 years, the S&P 500 gained 7.3 per cent and the Nasdaq, dominated by computer-related companies, soared 8.6 per cent - its biggest weekly gain in 24 years.

"It's what the market needs here in terms of a strong boost in confidence, particularly with the amount of negative sentiment of the past couple of weeks," said Gary Campbell, at Commerce Bank Investment.

Still, some investors are sceptical that stocks will rocket back to the records set in July. Stocks are relatively expensive when earnings growth is slowing. "I don't know yet whether this can be seen as the complete elixir to solve the world's very big problems [including deflation and global recession]," said Liz Ann Sonders, a money manager with Avatar Associates. "In terms of valuations, you still have some pretty healthy earnings expectations out there."

Third-quarter operating earnings for the S&P 500 are expected to drop 3.5 per cent. Analysts still call for average operating profits to grow 8.4 per cent in the fourth quarter and 19.4 per cent next year, and some think those forecasts are too high. Even if the Fed can stave off a recession, corporations are cutting spending, which will hurt profit growth.

The interest rate cut may also set the stage for a rebound in the $2,300bn (pounds 1,353bn) US corporate bond market. It signalled to investors that the central bank will do all it can to head off a credit crunch and a recession. That bodes well for company profits and boosts the appeal of corporate bonds.

The Fed cut "makes people more comfortable to dip their toe'' into corporate bonds, said Alan Koepplin, bond manager at SG Cowen Asset Management. "We've seen the worst." Copyright: IOS & Bloomberg