Sell the Fact

The old Wall Street chestnut, “Buy the rumor, sell the fact”, came to fruition yesterday. Just ten days ago, it looked like US equity markets were about to take a major drubbing, but then a rumor circulated that perhaps the Fed might step up its interest rate cut campaign. Indeed, the Fed cut interest rates by ¾% last week and then, for the second time in nine days, the central bankers dropped short-term lending rates to 3% and left the door open to more cuts in the future-- the accompanying statement noted “downside risks to growth remain” and the Fed would “act in a timely manner as needed to address those risks.”

You might have expected that such an aggressive monetary easing campaign in a short time would propel markets higher, but after attempting a post-Fed rally, investors sold off stocks by the end of the day yesterday. What’s going on -- isn’t a rate cut a good thing for stocks? The answer is, yes, it should be, but investors are still fighting off an almost endless barrage of bad news. In addition to the 2008 fears of recession and subprime spillover, the financial sector suffered a downgrade of the large bond insurer Financial Guaranty Insurance after the Fed announcement. The news led many to surmise that additional downgrades could force some institutions to sell securities that were previously AAA-rated, adding to the downside pressure.

The prospect of forced selling of an already-beleaguered asset class was enough to take the wind out of the Fed news and sober up the folks who had drifted towards the punch bowl of liquidity that had been rolled out by Bernanke and friends. The asset addicts were lured by the Fed’s market-motivated actions and comments: “Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity”. It’s almost as if they were saying, “come on in---the punch bowl has just been refilled and we know if you keep drinking it, everything will get much better!”

Before you drink from the Fed’s punch bowl and find yourself in a giddy state, remember that we are still in the midst of determining the damage --- of tallying losses at the nation’s banks, surveying the continued deterioration in the housing market and understanding the risks that lie ahead. I think that what will keep the market mired in the mud for a bit longer is the continued concern over the effects of the credit crisis and how it has infected other parts of the economy.

The good news is that the combination of an aggressive Fed and new fiscal stimulus should promote a healthy economy, eventually. Before you rush in, be forewarned that getting there could continue to be a messy process. Even the Fed acknowledged that “financial markets remain under considerable stress, and credit has tightened further for some businesses and households.” Now that’s a fact you don’t have to sell.