MarketView for December 16

Summary  

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Stock prices moved sharply higher on Tuesday after the Federal Reserve rewrote its playbook by slashing borrowing costs to a record low, while at the same time pledging more unconventional steps to fight the deepest recession in generations.

In a unanimous vote, the Fed made a larger-than-expected cut to the benchmark federal funds rate by at least three-quarters of a percentage point to a target range of zero to 0.25 percent from its current 1 percent. According to the Fed, it plans to employ all available tools to promote the resumption of growth and preserve price stability.

Bank stocks led the parade upward, spurred both by the Fed's move to cap its target lending rate at a quarter of a percentage point and by a quarterly loss posted by Goldman Sachs that was not as bad as had been expected. Goldman's shares ended the day up 14.4 percent to $76, outperforming an 11 percent advance in the S&P 500's financial index.

Stocks were up modestly all day on optimism that the Fed, at its last meeting of 2008, might take dramatic measures to combat the credit crisis and global economic slowdown. However, things really began to happen after the central bank released its statement in mid-afternoon, pushing the benchmark S&P 500 index to its highest closing point since November 10.

The day’s announcements sent each of the major stock indexes to their best one-day performance for the month, and it was the largest point and percentage gain for the Dow Jones industrial average since November 24 and pushed the blue-chip Dow average up 1.1 percent for the month to date. JPMorgan Chase was the Dow's top performer, up 13 percent at $32.35

Home builders' shares also jumped following the Fed's huge rate cut, which investors believe will help stimulate lending and home buying. Investor sentiment also improved after better-than-expected quarterly earnings from Best Buy, which buoyed technology stocks. Companies such as Microsoft and Intel, which draw significant revenues from consumer demand for electronic products, were among the NASDAQ’s top advancers.

Best Buy's stock rose 17.94 percent to $27.68 after its quarterly earnings exceeded estimates and an indication by the company that it was planning to offer employee buyouts and reduce store openings in an effort to combat reduced consumer spending. Microsoft advanced 5.6 percent to $20.11, while Intel gained 7.2 percent to $15.64.

Shares of General Electric rose 5.7 percent to $17.92 after the company issued guidance for the rest of 2008, but said that it will no longer be providing specific quarterly earnings-per-share guidance going forward.

Economic data earlier in the session continued to show effects of the recession, with consumer prices falling at a record rate for a second straight month in November and housing starts hitting a record low.

Fed Cuts Target Rate By 75 Basis Points

The Federal Reserve has cut its target for a key interest rate to the lowest level on record and pledged to use "all available tools" to combat a severe financial crisis and prolonged recession.

The central bank on Tuesday said it had reduced the federal funds rate, the interest that banks charge each other, to a range of zero to 0.25 percent. That is down from the 1 percent target rate in effect since the last meeting in October. Many analysts had expected the Fed to make a smaller cut of 50 basis points.

Federal Reserve Chairman Ben Bernanke and his colleagues also pledged to use "all available tools" as they struggle to contain a financial crisis that is the worst since the 1930s and a recession that is already the longest in a quarter-century. made clear that it intends to keep the funds rate at extremely low levels.

"The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the central bank's panel that sets interest rates said in a statement.

In addition to the rate cut, the Fed said it was prepared to expand a plan to purchase large amounts of debt issued or guaranteed by government-sponsored mortgage agencies. It also said it was mulling possible purchases of longer-term U.S. Treasury debt and would consider other ways to tap its burgeoning balance sheet to support the economy.

"The focus of the committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level," the Fed said.

The Fed has already pumped massive amounts of money into credit markets, pushing the size of its balance sheet to $2.2 trillion from $887 billion over the last three months. The rapid expansion in the Fed's balance sheet amounts to a form of "quantitative easing", a policy pursued by Japan earlier this decade to expand the supply and circulation of money after it was forced to lower rates to zero.

Japan, however, pumped excess reserves into the banking system to try to jump-start lending. In the Fed's case, officials are trying to circumvent lending-wary banks and target specific markets where credit is jammed.

The Fed's decision is expected to be quickly matched by a reduction in banks' prime lending rate, the benchmark rate for millions of business and consumer loans. Before the Fed announcement, the prime rate stood at 4 percent.

Major Drop In The CPI

Consumer prices fell in November at the fastest rate since 1932, the Labor Department reported on Tuesday, as prices for energy, commodities and airline fares were lower across the country. According to the Department, its consumer price index fell by a seasonally adjusted 1.7 percent, making it the largest decline since the government began adjusting the CPI for seasonal factors in 1947. On a non-seasonally adjusted basis, the CPI fell by 1.9%, the largest decline since January 1932, at the nadir of the Great Depression. At the same time, the seasonally adjusted core CPI was flat in November.

Energy prices were down by a seasonally adjusted 17 percent, making it the largest decline since February 1957. Gasoline prices were down 29.5 percent, the largest drop for that statistic since the government began keeping records in February 1967. Fuel oil prices fell 7.2 percent, while commodities prices were down 4.1percent in November.

Over the past year, overall consumer prices have risen by 1.1%, down from their peak of 5.6% in July. Core prices have risen by 2% in the last 12 months. Yet, prices for certain goods rose in November, even as the overall number fell. Medical care prices, for example, climbed by 0.2%. They are up 2.7% in the past year. Also, food prices rose by 0.2% in November.

The cost of owning a house, meanwhile, rose 0.3% in November. Falling transportation prices contributed to the overall decline. Those prices dropped 9.8% in November, the most in 61 years, and are down 8.9% over the past year.

OPEC Poised For Major Cut In Supply

Oil prices fell Tuesday after Saudi Arabia said oil production would be cut by 2 million barrels a day to stem declining crude prices. OPEC, expected to officially cut production levels on Wednesday, indicating that it likely will have to "shock" the marketplace in order to stabilize prices.

Venezuela's energy minister, Rafael Ramirez, called for a consensus on a "significant cut" which he said should be of between 1 million to 2 million barrels per day. Whether any announced cuts to production will stabilize oil prices remains to be seen. Two previous OPEC cuts amounting to about 2 million barrels a day earlier this year have done little to stem the slide amid the worst economic downturn in decades.

The severity of the economic downturn being faced across the globe has led to a sharp decline in oil prices. Light, sweet crude for January delivery settled down $1.02 per barrel at $43.49 on Tuesday. In London, January Brent settled up 8 cents per barrel at $44.68 on the ICE Futures exchange. Crude prices, which had been up close to $1 all morning, fell below $44 just after Saudi oil minister Ali Naimi said production would likely be cut by about 2 million barrels a day.

On Tuesday, OPEC predicted demand for its crude oil fell by 700,000 barrels per day this year, and will drop by at least twice that amount in 2009 as the worsening global economy "is expected to have a strong impact on oil demand."

With the demand for gasoline down during the winter months and the economy losing hundreds of thousands of jobs, the decline in demand for crude could easily go well beyond expectations. Evidence of this is seen in the data released Tuesday by MasterCard Spending Pulse for the week ended Dec. 12, indicating that Americans continue to cut their consumption of gasoline despite a drop in prices.

MasterCard's report is based on aggregate sales activity in the MasterCard payments network, coupled with estimates for all other payment forms, including cash and check. That trend suggests that even though some motorists are driving more as gasoline prices drop, the sheer number of people losing jobs and no longer driving to work all has reduced demand,.

Unfortunately, a severe drop in energy costs can lead to diminished exploration and production of crude, raising fears of another price shock when economies rebound. Oil prices, which reached a four-year low at $40.50 earlier this month, have fallen about 70 percent since peaking at $147.27 in July.