Expect More Rough Sledding for the Markets

What's needed for a return to bullishness? More evidence that market psychology is changing for the better

By Arnie Kaufman

The brevity of the celebration of the Fed's shift last week toward monetary ease and the absence of any apparent lift from the let-up in tax selling have done further harm to market psychology. Lightening up on rallies, regardless of the reason for the bounce, has become reflexive. The going will remain rough for a while.

Last week's rotation out of defensive groups, such as drugs, foods, utilities and tobacco, implies that money managers are now somewhat less concerned with shelters against recession than they had been. Yet, with the market's pre-Fed-action lows in for a quick test, they aren't ready to commit aggressively to sectors where revenues and earnings would benefit most once Fed rate cuts kick in.

Earnings news will get worse before it gets better. We now believe that operating profits on the S&P 500 for the fourth quarter of 2000 were unchanged, year-to-year, and that a decline of 3% will be seen in the current quarter.

Nevertheless, the market typically acts well in the months following the Fed's adoption of an accommodative monetary stance, as investors start to look across the valley to a recovering economy. In the 13 such instances since 1971, six months after the initial rate cuts, the S&P 500 and Nasdaq were up 11 times and down twice.

While last week's employment report for December indicated that labor cost pressures have not been eradicated, S&P chief economist David Wyss expects cuts in the fed funds rate, including last week's half-point, to aggregate 1 1/2 percentage points during 2001.

Bolstered by year-end bonuses, mutual fund distributions, company contributions to profit-sharing accounts, and year-end interest and dividends, the amount of potential investment money on the sidelines is sizable. Before switching to a more bullish policy, though, we'd like to see evidence that psychology is changing for the better.

Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook