Stocks drop, then rebound after cut

Specialist Charles Jenness rubs his head as he works at his post on the floor of the New York Stock Exchange on Tuesday.

The Associated Press
Published: Wednesday, January 23, 2008 at 6:01 a.m.
Last Modified: Tuesday, January 22, 2008 at 9:05 p.m.

NEW YORK - The opening bell hadn't even sounded on Wall Street when the Federal Reserve announced an emergency interest-rate cut. The Dow Jones industrial average fell 465 points then rebounded to finish down a more bearable 128.

The recovery Tuesday was a victory of sorts for a battered market. But a long-term comeback may depend on factors much more difficult to achieve - a turnaround in the housing market and renewed confidence among U.S. consumers, who hold up most of the economy.

The alarming early drop in U.S. stocks followed the lead of markets abroad, where investors fled stocks and sent indexes plummeting on fears of a U.S. recession that could spread to other global economies.

By the close, the Dow had recovered to a loss of 128.11, or just over 1 percent, at 11,971.19.

Before trading began, the Federal Reserve moved to slash its benchmark federal funds rate by 0.75 percentage points, to 3.5 percent. It was the widest cut since 1990, the beginning of what the Fed says is a comparable period in the way it handled the rate.

Many traders had anticipated a rate cut, but it was unusual for the Fed to make the call between regularly scheduled meetings of its policy-making Open Markets Committee.

The market pulled back a bit from its steep plunge - the Dow had fallen 277 points on Tuesday of last week, and 307 on Thursday. It was a positive sign, but economists and analysts said a full recovery was not likely in the near term.

The markets worry that consumers, who account for two-thirds of economic activity, are not in a position to spend the country back into solid growth. They have been cutting back rather than borrowing or spending more, even during the recent holiday season.

Interest rate reductions are one strategy the Fed has used in previous crises to help the economy recover. A rate cut tends to spur the economy by making it cheaper for businesses to borrow money.

It would also lighten the burden on individuals with credit card debt and with mortgages that have adjustable rates.

Investors are well aware that housing worries remain: Many adjustable-rate mortgages will still be adjusted higher, and home prices are expected to keep falling this year.

Financial companies have lost billions of dollars because of those mortgages, retail sales are falling and companies in general aren't on a spending spree.

Investors, both institutional and individual, are also in a defensive mode, and an interest cut won't immediately change that. In the week ended Jan. 15, when many on Wall Street believed a rate cut was in the offing, investors shoveled money into cash reserves at a record pace, according to iMoneyNet. Assets in money market funds ballooned by $15.96 billion to a high of $3.17 trillion.

And investors pulled an estimated $18.2 billion out of mutual funds, according to TrimTabs Investment Research. So far this year, investors have shifted $41.4 billion out of these investments.

For the market to truly gain a foothold, investors need to see strong economic and earnings data in the coming months, including earnings reports and forecasts this week from big multinational companies

The pack mentality of Wall Street could be the market's biggest driver - it's what triggered comebacks in the past, and one reason experts say long-term investors should sit tight.

When investors feel the market has indeed gone as low as it should, they'll start buying, even if the economy is not yet barreling higher.

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