Stocks Soar on Fed's 75-Point Rate Cut

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Although he sees the economy in or close to a recession, he believes if a downturn materializes it will be short and shallow. Raha bases that view on the hefty monetary stimulus that's in the pipeline, the temporary fiscal stimulus coming alter in the year, thin business inventories and the boost in exports from a weaker dollar.

The Fed's emphasis on the increasing inflation risk in its statement seems odd at a time when the focus is on reining in the effects of the financial crisis, but Stone at PNC says he thinks the Fed was probably just reminding the public about its mandate to ensure price stability as well as economic growth.

"The big thing is that the Fed is not behind the curve. It will address these problems as they come up," says Doug Roberts, chief investment strategist at Channel Capital Research in Shrewsbury, N.J. When events pose a potential risk to the financial system as a whole, as the liquidity drain at Bear Stearns did, the Fed "will address it and prevent it from spiraling out of control," he adds.

Skeptics argue that the Fed isn't reducing the moral hazard by continuing to cut rates and provide bailouts, but Roberts doesn't agree.

"They're not going to guarantee that somebody’s going to get out of this alive," he says. "With Bear Stearns, [the Fed] said, 'This is the sale, there’s no room for negotiation because there's too much risk to the system. Making sure you get a return on your investment is not our concern.'"

Citing the mixed signals from February's inflation reports, Roberts said he believes the Fed is betting that inflationary pressures will ease over time.

Whether the stock market can sustain the investor optimism seen Tuesday is anyone's guess. PNC's Stone said he'd like to hope that the financial crisis is nearing an end, with the Bear Stearns collapse serving as the requisite crescendo.

"Valuations for stocks are very inexpensive relative to safe investments, like Treasuries," he says. "It's wholly unappetizing to buy Treasuries at these levels."

With stocks in the S&P 500 Index offering an average dividend yield of 2.30%, vs. a 1.58% yield for 2-year Treasury bonds, investors seem to be getting paid for taking a risk on equities right now, he says. "So you can afford to sit in stocks. It's rare that you get stocks yielding more than 2–year Treasurys," he says.

Stone's view is a lot sunnier than the one that Massimo Tosato, vice chairman of the fund firm Schroders, expressed to Reuters on Tuesday. Speaking at a funds summit in Luxembourg, Tosato said that the credit crisis could last for the next 12 to 18 months, while retail investor appetite for risk could take up to two years to return, according to a Reuters news advisory.

Traders were encouraged Tuesday by better than expected earnings from Goldman Sachs (GS) and Lehman Brothers (LEH). The market largely ignored a larger than expected rise in the February core producer price index and a dip in February housing starts.

On Monday, investors digested news of JPMorgan Chase (JPM) acquiring Bear Stearns (BSC) for $2 per share, and the Federal Reserve cutting the discount rate and taking steps to expand lending to big financial firms.

The Fed has been unusually active in the run-up to the FOMC meeting, to say the least. The Fed basically brokered the JPMorgan-Bear deal over the weekend, and took some remarkable steps to ease the stress on financial markets -- its first weekend move in nearly 30 years. The U.S. central bank cut the discount rate on Sunday to 3.25% from 3.5%, and announced that it will lend to the 20 primary dealers that buy Treasury securities directly from it -- a tool not used since the Great Depression. The Fed will also provide up to $30 billion to JPMorgan to help it finance the purchase of Bear Stearns.