All Eyes On Greenspan
The markets will turn their focus on the FOMC meeting tomorrow in hopes of a rate cut from Greenspan and his elves. At this point, whether the Fed cuts rates is a tossup. About a week ago, the Washington Post reported that the Fed is unlikely to cut rates this time around. Instead, the Fed is expected to maintain a neutral bias ahead of cutting rates later in January. However, an article in the Wall Street Journal this morning suggested that the Fed may pursue a more aggressive stance at its meeting tomorrow and actually cut rates. That article helped to spur a broad and significant rally across several sectors today, which added credence to the Journal's claims.
Moreover, the Fed Funds Futures are now discounting about a 50% probability of an ease tomorrow. Those same futures have already discounted a full two rate cuts by at least this spring. The bottom-line is a cut in interest rates is coming, but the question remains as to how soon the Fed will move, which brings us back to tomorrow's meeting. Traders should pay heed to the ramifications of an interest rate cut tomorrow. If the Fed does cut rates, we'll likely see an extended rally in the most interest rate sensitive groups such as financials, utilities, and consumer product makers, among others. On the other hand, if the Fed merely shifts its bias to neutral and doesn't cut rates, we could see a pullback in the aforementioned groups as the usual "sell the news" crowd surfaces. The impact of a rate cut on the likes of financial and consumer product makers is rather obvious, but the impact on the tech names is a little more clouded.
As we witnessed today, after the Wall Street Journal's suggestion of a rate cut, the interest rate sensitive groups rallied, but the Nasdaq rolled over. The poor action in the tech sector today is a direct reflection of the deteriorating fundamentals in that group. Continued earnings warnings, bearish news and analyst downgrades are weighing on the Nasdaq. And If the Fed does actually cut rates tomorrow, the impact on the tech sector is harder to game. Any rally off the news of a rate cut tomorrow could be met with heavy selling as we've witnessed time and again in the Nasdaq over the last several months. Until the last of the tech generals warn, and all the bad news is discounted in the Nasdaq, the path of least resistance may remain to the downside. That's the problem we face with the Nasdaq tomorrow if the Fed actually does cut rates. The tech sector is still coping with poor fundamentals, but will an interest rate cut be enough to shift sentiment in the near-term?
If there's one positive event we can write about in the Nasdaq, it's the fact the tech-heavy index bounced off support at the 2600 level for the second consecutive day. It was somewhat reassuring to see the buyers step in at 2600 and carry the Nasdaq higher. At least we know some institutions are willing to let the Nasdaq fall only so far before stepping up and taking some stock in. We'll be watching the action in the Nasdaq around the 2600 level very closely tomorrow to see if it continues to hold. If 2600 does fail, the next likely level of support will be found at 2567, which was the low on December 4th.
The weakness in the Nasdaq today can be attributed to the further signs of the worsening fundamentals we mentioned above. Terayon (TERN), a maker of broadband network systems, warned this morning that it wouldn't meet its estimates for the fourth-quarter. The company blamed its shortfall on an unexpected slowdown in sales and on canceled orders from cash-short customers. Although Terayon is not considered a big player in the networking space, its warning caused a widespread sell-off among others in its sector including Avanex (AVNX), Sycamore (SCMR), Ciena (CIEN), Extreme (EXTR), and the mighty Cisco (CSCO). Shares of Cisco were hit especially hard with a 10% loss. The stock fell over $5 and was responsible for much of the losses in the Nasdaq Composite (COMPX). The sell-off in Cisco today reinforces just how hard it is in the tech sector right now. Not too long ago, Cisco reported earnings that beat estimates (as usual) and actually raised guidance for 2001 - its shares now sit at a new 52-week low after today's session.
Time Warner (TWX) joined the ranks of company's to preannounce an earnings shortfall. The media giant said it would fall short of earnings this quarter due to weakness in advertising, softness in music sales and losing money of its recent box office bomb, "Little Nicky." Time Warner's merger partner, America Online (AOL), reaffirmed guidance for its fourth quarter. Despite the reassurance from AOL, shares of the two merger partners both fell by about 13%.
Despite the two above-mentioned warnings in the tech and media sectors, the prospects of a rate cut tomorrow powered the Dow Jones Industrial Average (INDU) higher. Every financial component in the INDU enjoyed gains, which included: JP Morgan (JPM), American Express (AXP) and Citigroup (C). Among many others, the three aforementioned financial names will be ones to watch ahead of the Fed meeting tomorrow.
The highly-visible diamond formation from which the INDU broke to the downside last week has now turned into resistance for the interest rate sensitive index. In fact, the INDU rolled over right near its previous support line this afternoon as profit takers locked in their recent gains. The key levels to watch tomorrow in the INDU will be today's intraday high at 10,679 followed by the 10,700 level, with the latter a psychologically and technically significant level. If the INDU can break back above its previous support line, it has a good shot at retesting its near-term highs around the 11,000 level, especially if the Fed cuts rates.
Also worth noting this evening is the Electoral College's vote to certify George W. Bush as the next president of the United States. Some traders had speculated that foreign investors would wait until Bush was officially certified before moving capital back into the domestic markets. The news tonight might help to give equities a lift tomorrow if the foreign investors haven't already moved back into the U.S. markets.
As we've been writing, the markets will trade around the FOMC meeting tomorrow, which is expected around 2:15 EST. Whether the Fed actually lowers rates is at best a guess right now. Although the Wall Street Journal's article this morning lends to that course of action, it's still up in the air. It's impossible to say with certainty what the Fed will do. The market has discounted a shift to a neutral bias, but not a cut in rates. And with that uncertainty comes greater risk for options traders who choose to take positions ahead of the announcement. The more prudent and less-risky approach would be to wait for the official announcement from the Fed before betting on either direction in the markets. As we've detailed, the direct and almost immediate beneficiaries of a rate cut are likely to be financials, consumer products makers, and utilities, among others. If the Fed does actually cut rates, those groups of stocks will likely enjoy a sustained rally that can be taken advantage of after the announcement. On the other hand, if the Fed just shifts its bias, we're likely to see a sell on the news event, in which case the aforementioned sectors pullback. In either case, it's very crucial in the current market environment to trade with the prevailing trend. Let the market dictate!
As for the tech sector, there's still a lot of uncertainty in that group of stocks in the form of earnings worries and continued bearish sentiment. A cut in rates, at this point in time, may not be enough to kick the Nasdaq into rally mode. Then again, sentiment can shift rather quickly, so it's key to be on your toes and very nimble in the Nasdaq.
With continued weakness in the leaders of the Nasdaq such as Cisco, Sun Microsystems and Microsoft, it will be hard for that index to sustain a substantial rally. But that doesn't mean the upside moves cannot be traded. What it does entail, however, is discipline! Consider entry points carefully, calculate risks and gauge exit points. For those who continue to operate in the Nasdaq, it's best to do so without any emotion. By planning ahead - before the trade - a lot of emotion can be removed.
Whatever transpires tomorrow, it's sure to be exciting and provide plenty of opportunities to profit. Let the market be your guide and good luck!