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Market Wrap

Stocks Plunge on Fed Announcement

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     01-28-2004            High     Low     Volume Advance/Decline
DJIA    10468.37 -141.55 10658.43 10437.78 2.29 bln    740/2166
NASDAQ   2077.37 - 38.67  2128.00  2073.15 2.30 bln    840/2263
S&P 100   559.49 -  7.66   569.55   558.27   Totals   1580/4429
S&P 500  1128.48 - 15.57  1149.14  1126.50
RUS 2000  583.91 - 11.26   598.46   582.84
DJ TRANS 2967.68 - 73.54  3044.87  2964.88
VIX        16.78 +  1.43    40.13    15.29
VXO        17.10 +  1.78    17.11    15.24
VXN        25.16 +  2.13    25.21    22.83
Total Volume 5,145M
Total UpVol  1,040M
Total DnVol  3,963M
52wk Highs     636
52wk Lows       12
TRIN          1.39
PUT/CALL      0.85

With just a few choice words the FOMC was able to do what the bears have been unable to accomplish - put the bulls on the run. Stocks traded mostly higher earlier in the session, despite some disappointing economic news until the Fed's decision on interest rates sparked a very widespread sell-off. The Dow's 141-point (1.33%) drop was the worst one-day decline in three months for the index. The NASDAQ plunged 1.82% and the S&P 500 fell 1.36%.

Generally positive earnings news helped lift stocks early on but by the end of the session only one sector remained in the green. That was the utilities index, which added 1.16%. Odds are investors fled to these higher-dividend yield issues as a safe haven. The heaviest selling showed up in homebuilders and airlines but natural gas stocks, broker-dealers, networking, hardware, retail and gold issues all fell sharply.

Overseas markets were mixed. European stocks were mostly higher while Asian exchanges posted losses. The Chinese Hang Seng index dropped 330 points or 2.4% to close at 13,431. There didn't appear to be any news on the decline but I suspect it was a reaction to the resurgence of Avian flu, a deadly strain that Thailand recently admitted to hiding its own recent outbreak. Investors fear that the outbreak, now in six Asian countries, will affect air travel to the region and the XAL airline index dropped 5.25%. Compounding the XAL's losses were negative comments from Goldman Sachs who downgraded JetBlue Airways (JBLU) to an "under perform". JBLU is expected to announce earnings tomorrow morning before the bell. Estimates are for 17 cents a share.

Market internals for the U.S. stock markets were probably the most bearish we've seen in quite some time. Declining stocks outnumbered advancers 3-to-1 on the NYSE and 11-to-4 on the NASDAQ. Down volume was more than three times up volume on both exchanges. The volatility indices spiked higher with the VXO (old VIX) gaining 11.6% to 17.1 and the new VIX jumping 9.3% to 16.78. These are still low readings but they are setting the stage for a bearish move in the markets.

Prior to the Fed's afternoon decision on interest rates investors were greeted with a disappointing durable goods order report. Estimates had been for a 2% rise in December to offset a 2.3% drop in November. Unfortunately durable goods orders were unchanged last month. Wall Street also had to digest a drop in new home sales. The Commerce Department reported this morning that December's new home sales slipped 5% to a seasonally adjusted rate of 1.06 million units. This is still a very healthy rate and pushed the number of new homes sold in 2003 to 1.085 million, a new record. Yet it was a disappointment and sent the homebuilders to early losses.

Now we get to the real reason the markets sold off. The Federal Reserve's two-day meeting ended today and the Fed governors voted unanimously to keep the fed funds rate at 1 percent, the lowest level since 1958. No one actually expected a change in rates and the focus was on the Fed's bias. Would they keep the "considerable period" language or not? The answer was no. Jim called it in last night's wrap. With upside and downside risks "roughly equal" and the markets soaring to new 2 1/2 year highs the FOMC opted to change their bias to "can be patient" with its accommodative stance. The full text of the Fed's statement follows:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 1 percent.

The Committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity. The evidence accumulated over the intermeeting period confirms that output is expanding briskly. Although new hiring remains subdued, other indicators suggest an improvement in the labor market. Increases in core consumer prices are muted and expected to remain low.

The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.

No one knows what sort of time frame "patient" equates to but the market assumes it's shorter than the previous "considerable period". The reaction was immediate. Bond prices plummeted. The yield on the 10-year note shot from 4.08 percent to 4.199 percent. The U.S. dollar rose against the yen and the euro and gold jumped $4.50 to close at $414.60 an ounce. Investors immediately hit the sell button and stocks plunged. The previous losses in the homebuilders grew worse by the close. The move in bonds will push mortgage rates higher, which in turn will slow home sales during an already seasonally slow period (no one likes to go house hunting in the snow).

Analysts reaction to the new language was all over the board. Some felt it was a monumental change; others described it as a baby step toward inching rates higher. Odds that the Fed might hike interest rates in June or August this year spiked higher but there are still plenty of pundits who feel the Fed won't move until next year. Any time Greenspan speaks the markets analyze every word for some sign of change in the Fed's monetary policy. We'll get to here from him again next month with his February 11th appearance before the House Financial Services Committee, on February 12th in front of the Senate Banking Committee and again on February 25th before the House Budget Committee.

The Fed decision was obviously the big story today but there were plenty of stock-specific stories making headlines as well. Tenet Healthcare (THC) was one of them. Shares of THC dropped 18% to $13.18 after warning that its Q4 and full year numbers would be below estimates. THC also announced it would be selling 27 of its 96 hospitals in a massive restructuring program. Volume was extremely high at 37 million shares compared to the average 3.5 million. The company was already suffering investor flight due to a government probe into its billing practices.

Dow components making the news were PG, DD and MO. Procter and Gamble (PG) reported its December quarter earnings, which were slightly ahead of estimates but issued less than inspiring comments for the current quarter. DuPont (DD) reported earnings last night and beat estimates by 4 cents on revenues that surpassed expectations. The company guided slightly higher for the current quarter and ended the day as the Dow's best performer. Altria Group (MO) also bucked the downtrend today coming in right behind DD as the second best performer in the Dow after reporting earnings that were in-line. MO's revenues did beat consensus estimates and shares added 1.18% but I suspect the gain was investors fleeing to high-dividend yielding stocks as a safe haven.

One of today's biggest topics was the MyDoom virus. The MyDoom virus, also known as Novarg or Shimgapi has suddenly ballooned into the worst virus (or worm) attack to date surpassing the SoBig virus last year. Some reports suggest that 1 in 9 emails over the last couple of days were infected with the virus and the clean up costs could top $250 million as corporations scramble to unclog and protect their networks. The MyDoom story is interesting because infected computers are left with a trojan, which is set to direct Denial of Service attacks against the SCO Corp. You may remember SCO for its ongoing litigation against IBM and any one else selling servers with the Linux software. SCO claims that Linux uses copyrighted code from the UNIX operating system of which SCO holds significant rights to. Widespread virus attacks like these tend to draw attention to Symantec (SYMC) and Network Associates (NETA), both of which recently hit new relative highs.

Chart of the DJIA:

Chart of the NASDAQ:

Looking over the action in the major indices one has to wonder if this is the beginning of the long overdue correction everyone has been waiting for. The change in the Fed's language is a great "excuse" to start taking more money off the table, which wouldn't be a bad thing. A 5% pull back from the Dow's recent highs would not even bring it back to the 10,000 mark. A similar drop in the NASDAQ would still leave it above the 2000 level. Technical traders will point to the Dow's close under the 10,500 level and its close under the 21-dma, where the index bounced on Jan. 13th, as a short-term bearish development. The NASDAQ looks even worse with its close under 2100. The reality is any sort of significant pull back will be healthy for us. There is still plenty of money sitting on the sidelines just waiting for the right "dip" and a pull back to 10K or 2K might be just what these investors are looking for.

Tomorrow will bring even more earnings announcements but we'll also hear the latest weekly jobless claims numbers. Economists are expecting 341,000 claims, which is almost unchanged from last week. We'll also get the Employment Cost Index tomorrow and Friday brings the University of Michigan Sentiment index for January, the Chicago Purchasing Manager's Index and the all important fourth-quarter GDP number. If the economic data remains positive investors should continue to be there waiting for the next dip.


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