A Slam Dunk by Air Greenspan


By Margaret Popper Among his many accomplishments, you have to wonder if Alan Greenspan secretly plays basketball in his spare time. Because what have the past 3 1/2 months of Federal Reserve maneuvering been if not an elaborate series of head fakes on the way to a slam dunk? Ever since an unexpected cut between policymaking meetings on Jan. 3, the Fed has been toying with market expectations. After disappointing investors in February, it spent most of April sending oblique signals that it would wait until its May 15 policy meeting before cutting again.

Then -- wham! On Apr. 18, the Fed delivers a half-percentage-point chop midway between its March and May policy sessions. The stock market expressed its glee with an 8% rise in the Nasdaq and a 4% jump in the Dow Jones industrial average. If it was a little bit of Fed grandstanding, surely Greenspan can be excused. Today's surprise was delivered exactly how it had to be for the maximum psychological benefit without giving the impression the Fed is the market's stooge (see BW Online, 4/12/01, "The Case for a Rate Cut Now").

The Fed easing comes just as the market is stabilizing and companies are rapidly correcting inventory overhangs. The move was timed to ensure that investors held onto the market's recent gains so that the all-important consumer, who generates two-thirds of economic activity, hangs in there and keeps spending. At the same time the Fed wants to preempt corporations from reacting to disappointing earnings with layoffs that would kill consumer confidence. The timing means the Fed could well ensure that the economy averts recession. With luck, by this time next year, the Fed will be more worried about inflation than recession.

CONFIDENCE-INSPIRING. "This rate cut may be well-timed for consumer sentiment," says Harry Dent, president of the H.S. Dent Foundation, a money-management and advisory firm. "Consumers were getting tired of waiting for the market to turn around convincingly." The Fed-inspired rally of Apr. 18 helped to build confidence in the market and convince consumers to stay invested. "The market was already in a rally that was sustainable, but not likely to improve much," says Dent. "With the Fed's cut, the odds are much greater that the market has put in a bottom."

The Fed's stated reasons for the cut make the economic situation sound dire. The central bank cited concerns about the potential effect of the stock market decline on consumer spending, the precipitous decline in capital spending and corporate earnings, and slower-than-expected economic growth abroad. All concerns that have been valid for several weeks now. "The data from March looks a lot worse than January and February," points out Marci Rossell, chief economist for Oppenheimer Funds.

But on closer inspection, the economic data aren't dreadful, just weak. While consumer sales sagged in February and March, Instinet Research's Redbook Retail Sales Average rose 1.4% during the first week in April compared to the same week in March. Granted, it's only one week's data, but that's 3.1% higher than the first week of April, 2000. At the same time, housing starts showed a decline of 1.3% for March, the first sign of weakness in 2001, but hardly a cave-in considering the underlying strength of the housing market.

CUSP OF CONTRACTION. On the corporate side, figures from the National Association of Purchasing Managers aren't quite as promising. Prices are down, which, by the way, gives the Fed more room to maneuver without worrying about inflation. And manufacturing output is up slightly, although still in contracting territory, according to Mike Ryan, senior fixed-income strategist for UBS Warburg. But nonmanufacturing output is down slightly and on the cusp of contraction, although still in growth territory, adds Ryan.

Then there's the mixed message from the trade deficit. It shrank from $33 billion in January to $27 billion in February, suggesting "the American consumer is no longer in a position to hold up the world," says Oppenheimer's Rossell. Without Americans buying goods from abroad, foreign markets will slow more, and that eventually hurts U.S. sales.

The Fed's move also comes at a time when investors have finally accepted a new reality about the tech sector. Witness its reaction on Apr. 17 and 18 to Cisco, Intel, and Hewlett-Packard's announcements of sharply lower earnings -- barely a murmur. In fact, despite announcing additional layoffs of 3,000 people, HP's assurances that the earnings outlook would clear after the second quarter was regarded as good news.

TECH TURMOIL. But Air Greenspan understands as well as anyone that the tech sector, which has driven such a big chunk of overall growth the past few years, is hardly free of what ails it. "We think tech companies will show negative earnings comparisons [to 2000] through yearend," says Milton Ezrati, senior economist and strategist for fund manager Lord, Abbett & Co. in Jersey City, N.J. He sees the current climate in the tech sector as a buying opportunity. "Not because earnings will be robust, but because the market has already priced in the disappointments," he adds.

A crucial support to capital spending in this sector and others is credit availability. Particularly with large credit problems looming in the California utility sector that could affect just about every sizeable financial institution in the country, the Fed is still concerned that banks will stop lending, according to Ezrati. By continuing to cut rates, the Fed will try to ensure that if the system has to respond to a shock like a California utility meltdown, "No bank will say 'no'," says Ezrati.

Available capital will help the most troubled areas of tech. "Easier money will help the cash-strapped CLECs [competitive local exchange carriers], which are teetering on the edge of bankruptcy. It's not that they don't have valid business plans, but because they focused so much on build-out that they never got a chance to generate revenues," says Noel DeDora, a managing director and senior portfolio manager of U.S. equities at Fremont Investment Advisors. Winstar, which filed for Chapter 11 on Apr. 18, is a case in point.

The Fed likely will deliver another cut at the May 15 meeting, and it wouldn't surprise many people if it were another half percentage point, bringing the Fed's total easing this go-round to 2 1/2 percentage points. "Greenspan is not looking for a reason to cut, he'll cut until he has a reason not to," says Louis B. Crandall, chief economist at New York-based consultant R.H. Wrightson & Associates. And the markets learned once again on Apr. 18 not to underestimate the master of outsmarting the markets. Popper covers the markets for BW Online in our daily Street Wise column


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