RATE CUTS STABILIZE STOCKS -- TECHNICAL DAMAGE REMAINS -- FINANCE AND CONSUMER DISCRETIONARY SECTORS LEAD RECOVERY -- THE LAG BETWEEN STIMULUS AND RESPONSE

FED CUTS RATES TO BOLSTER STOCKS... Today's Market Message was written by Arthur Hill. John Murphy will return next week. - Editor

With stock markets around the world falling sharply on Monday, the Fed stepped in ahead of schedule by cutting both the Fed funds rate and the discount rate 0.75% today. This emergency cut came one week ahead of the FOMC meeting on 29-30 January. Incidentally, today's discount rate cut was the biggest discount rate cut since December 20, 1991. The S&P 500 went on to break a major resistance level at 400 that month (Chart 1). Also notice that the index moved back above its 50-day and 200-day moving averages with a decisive move in December 1991.

Chart 1

That was then. This is now. The early response to today's rate cuts was fairly positive as stocks rebounded after a weak open. However, a recovery after a weak open is not enough to erase January's technical damage. Three items stand out on Chart 2. First, the S&P 500 broke below the 50-day and 200-day moving averages. Second, the 50-day moved below the 200-day for a dead cross. Third, the S&P 500 broke the support zone from the August and November lows. Recapturing the broken support zone is the first step to reversing this technical damage. The support zone (1375-1425) turns into a resistance zone to mark the first big test for an oversold bounce. Let's see the bulls retake 1425 before considering any advance more than just an oversold bounce.

Chart 2

FINANCE AND CONSUMER DISCRETIONARY LEAD REBOUND... The Finance SPDR (XLF) and the Consumer Discretionary SPDR (XLY) were the strongest sectors on Tuesday. Both opened weak, but rallied sharply on the heels of the Fed cuts. The finance sector benefits from lower interest rates because it reduces borrowing costs and stimulates demand for loans (banks). The consumer discretionary sector benefits as more money becomes available for consumer spending (retailer). This is part of the economic logic behind the rate cuts, but there is often a gap between stimulus and response. Therefore, we need to keep an eye on the charts for bullish technical evidence before considering a trend change.

Even though today's recovery is impressive, it is still a mere blip within a larger downtrend. In other words, one recovery day is not enough to undo months of decline. Chart 3 shows the Finance SPDR below the 50-day and 200-day moving averages. Both moving averages are also trending lower with the 50-day well below the 200-day. Broken support, the 50-day moving average and the October trend line combine to mark resistance around 28-30. Chart 4 shows the Consumer Discretionary SPDR with a setup similar to the Finance SPDR. XLY opened weak, but recovered its losses with an impressive rebound. However, the overall trend is clearly down and I would view this as an oversold bounce for now. Broken support, the October trend line and the 50-day moving average converge to mark a resistance zone around 32.5-33.5.

Chart 3

Chart 4

Chart 5

Chart 6

RATES AND STOCKS FALLING TOGETHER... Before getting too excited about further rate cuts, we should keep in mind that stocks have nothing to show for a series of rate cuts since August. Even though it can be dangerous to fight the Fed, it can be even more dangerous to fight the trend, which is currently down for stocks. The 10-Year Note Yield ($TNX) peaked in June and has been falling the last seven months. Despite lower rates, the S&P 500 peaked in October and fell sharply over the last three months (Chart 7).

Chart 7

Lower interest rates are supposed to be positive for stocks, but both the S&P 500 and the 10-Year Note Yield (interest rates) have been falling together for three months. Because stocks have yet to respond to lower interest rates, more rate cuts may not be the panacea for the stock market. Not immediately at least. Chart 8 shows the Dow Industrials and the five rate cuts. It all started with a surprise 0.5% cut in the discount rate on 17 Aug. Despite four more cuts since then, the Dow Industrials is over 1000 point below its 17 August close. The Fed, the Congress and the President are doing their best to stimulate economy, but let's see some stimulus in the charts before getting excited.

Chart 8