Stocks Surge on Rate Cut Hopes

Market expectations of a Fed easing -- and optimism that big banks can fix their capital problems -- sent indexes soaring Wednesday

by David Bogoslaw

An empty roar? The rest of the week will tell, but on Wednesday a few gloomy economic releases, a few negative announcements from financial firms, and a few encouraging words from a Federal Reserve official were enough to send Wall Street off to the races.

A big rally in the major U.S. indexes was led by financial issues as the market responded to growing optimism about a Fed rate cut on Dec. 11 and to a Wall Street Journal report that Citigroup (C) had rejected a merger proposal from Bank of America (BAC). Sharply lower oil prices also helped to fan investors' enthusiasm.

This was the first time this month that equity indexes logged gains for two consecutive days, and it was the biggest two-day rally seen in the market in five years, according to CNBC Business News.

As of Tuesday, November was shaping up to be the worst month for equities in the past five years. Wednesday's surge may have changed that, but with two trading days still to go -- and the indexes' recent propensity for big daily swings of 1% or more -- stock players may not want to get too comfortable.

On Wednesday, the Dow Jones industrial average jumped 331.01 points, or 2.55%, to 13,289.45. The broader S&P 500 index rose 40.79 points, or 2.86%, to 1,469.02. The tech-heavy Nasdaq composite index gained 82.11 points, or 3.18%, to trade at 2,662.91.

On the New York Stock Exchange, 29 stocks were gaining for every four that were being sold, while Nasdaq breadth was 24-6 positive amid active trading. All 30 Dow components closed higher on Wednesday.

Words from Federal Reserve Vice Chairman Donald Kohn on Wednesday sparked some hopes for a Fed rate cut at its Dec. 11 policy meeting. Kohn said in a speech that he factored some tightening of credit from the financial turmoil into his policy decisions, but recent turbulence may restrict credit more than previously thought.

"Uncertainties about the economic outlook are unusually high right now," Kohn said. "These uncertainties require flexible and pragmatic policymaking."

Given that Kohn was already seen in the camp of those Fed governors likely to vote for an easing in rates, Action Economics said the markets are giving too much weight to his remarks.

Kohn's dovish tone helped to offset more negative news from financial sector. Wells Fargo (WFC) confirmed it set aside $1.4 billion to cover mortgage losses, while housing agency Freddie Mac (FRE) announced a $6 billion stock issue and 50% dividend cut.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, thinks capital infusions for big financial institutions have helped propel the market in the last two days. "The common theme is the ability of the financial behemoths to raise capital, in Citigroup's case from Dubai and also Freddie Mac and the preferred [stock offering]."

These developments suggest the pressure valve of these companies' ability to meet their capital requirements has been released a little bit, Ablin added.

For many market observers, however, the two-day rally only confirms the wild volatility that has pervaded the equities market since the summer's credit crisis. Many people remain skeptical that the financial sector has put in a bottom yet, with more losses and writedowns seen ahead. Others believe the major market correction indicated by 10% declines in the major indexes since the October highs needs more time to fully play out.

The prospect of a rate cut on Dec. 11 is a big factor in the stock rally, with a 90% chance that Ben Bernanke & Co. cut the Fed funds rate by a quarter percentage point, Ablin said. "So the Fed does have a little room to surprise the market if they want to knock it down a half-point."

In economic news Wednesday, U.S. durable goods orders fell 0.4% in October after a 1.4% drop in September (revised from -1.7%). However, orders are up 0.3% year-over-year. Transportation orders rose 0.2% after declines of 7.