Stocks Surge on Rate Cut Hopes

Market expectations of a Fed easing -- and optimism that big banks can fix their capital problems -- sent indexes soaring Wednesday

An empty roar? The rest of the week will tell, but on Wednesday a few gloomy economic releases, a few negative announcements from financial firms, and a few encouraging words from a Federal Reserve official were enough to send Wall Street off to the races.

A big rally in the major U.S. indexes was led by financial issues as the market responded to growing optimism about a Fed rate cut on Dec. 11 and to a Wall Street Journal report that Citigroup (C) had rejected a merger proposal from Bank of America (BAC). Sharply lower oil prices also helped to fan investors' enthusiasm.

This was the first time this month that equity indexes logged gains for two consecutive days, and it was the biggest two-day rally seen in the market in five years, according to CNBC Business News.

As of Tuesday, November was shaping up to be the worst month for equities in the past five years. Wednesday's surge may have changed that, but with two trading days still to go -- and the indexes' recent propensity for big daily swings of 1% or more -- stock players may not want to get too comfortable.

On Wednesday, the Dow Jones industrial average jumped 331.01 points, or 2.55%, to 13,289.45. The broader S&P 500 index rose 40.79 points, or 2.86%, to 1,469.02. The tech-heavy Nasdaq composite index gained 82.11 points, or 3.18%, to trade at 2,662.91.

On the New York Stock Exchange, 29 stocks were gaining for every four that were being sold, while Nasdaq breadth was 24-6 positive amid active trading. All 30 Dow components closed higher on Wednesday.

Words from Federal Reserve Vice Chairman Donald Kohn on Wednesday sparked some hopes for a Fed rate cut at its Dec. 11 policy meeting. Kohn said in a speech that he factored some tightening of credit from the financial turmoil into his policy decisions, but recent turbulence may restrict credit more than previously thought.

"Uncertainties about the economic outlook are unusually high right now," Kohn said. "These uncertainties require flexible and pragmatic policymaking."

Given that Kohn was already seen in the camp of those Fed governors likely to vote for an easing in rates, Action Economics said the markets are giving too much weight to his remarks.

Kohn's dovish tone helped to offset more negative news from financial sector. Wells Fargo (WFC) confirmed it set aside $1.4 billion to cover mortgage losses, while housing agency Freddie Mac (FRE) announced a $6 billion stock issue and 50% dividend cut.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, thinks capital infusions for big financial institutions have helped propel the market in the last two days. "The common theme is the ability of the financial behemoths to raise capital, in Citigroup's case from Dubai and also Freddie Mac and the preferred [stock offering]."

These developments suggest the pressure valve of these companies' ability to meet their capital requirements has been released a little bit, Ablin added.

For many market observers, however, the two-day rally only confirms the wild volatility that has pervaded the equities market since the summer's credit crisis. Many people remain skeptical that the financial sector has put in a bottom yet, with more losses and writedowns seen ahead. Others believe the major market correction indicated by 10% declines in the major indexes since the October highs needs more time to fully play out.

The prospect of a rate cut on Dec. 11 is a big factor in the stock rally, with a 90% chance that Ben Bernanke & Co. cut the Fed funds rate by a quarter percentage point, Ablin said. "So the Fed does have a little room to surprise the market if they want to knock it down a half-point."

In economic news Wednesday, U.S. durable goods orders fell 0.4% in October after a 1.4% drop in September (revised from -1.7%). However, orders are up 0.3% year-over-year. Transportation orders rose 0.2% after declines of 7.

0% in September and 12.4% in August; excluding transportation, new orders were down 0.7%. Nondefense capital goods orders excluding aircraft were down 2.3%. Shipments rebounded 0.6% after a cumulative decline of 3.6% over the prior two months. Nondefense capital goods shipments excluding aircraft were down 1.2%. Inventories rose 0.2%. The inventory/shipment ratio dipped to 1.47 from 1.48.

While the headline data are weaker than expected, the overall volatility in the data, and the mix of this data set, probably won't give much direction to the markets, says Action Economics.

The report revised the third-quarter GDP component outlook by shaving $1 billion from Action Economics' assumption of a $14 billion boost to third-quarter inventories and adding $1-$2 billion to its assumed $4 billion increase to fixed investment. Action Economics said it still expects a sharp upward revision in third-quarter GDP growth to 4.8% from 3.9%, while its fourth-quarter forecast remains at 1.7%. For equipment and software spending, it expects the 5.9% gain in the third quarter to rise to around 6.5%, and now sees a 1% rate of decline in the fourth quarter instead of its prior flat forecast.

The Fed Beige Book, covering the survey period of October to mid-November, showed a slowing pace to economic growth, with retail spending relatively soft and retailers expecting a slow holiday season. The Dallas Fed reported a rise in demand for legal services for bankruptcy filings, a sign of a weakening economy.

Ablin at Harris predicts that retail sales will climb 2% to 4% this Christmas from a year ago, about half the growth rate seen in last year's holiday season.

Existing home sales fell 1.2% in October to an annualized rate of 4.97 million units from a revised 5.03 million units in September. Economists had expected a decline to a 5.00 million annualized rate in October. Single-family home sales were unchanged in October, while multi-family sales fell 9.1%.

October's sales decline extended the big August-September drop-off, which suggests that disruption effects from credit market turmoil continued for another month. The 3.0% bounce in October housing starts reported last week had fanned some hope that the mortgage market bottlenecks following August's market seize-up were unwinding, but that didn't pan out. It may be that the natural lag in the existing home sales figures, since they are counted at closing rather than initiation, may have delayed any bounce, though any rebound in November would be from a much weaker level, Action Economics said.

"Given recent developments in the financial markets, it is too soon to say that October's diminished rate of decline in sales is a sign of potential stabilization," Bear Stearns' U.S. chief economist John Ryding said in a research note. He also noted that the three-month rates of decline in home sales are more than double the 12-month decline rates.

The era of $100-a-barrel will have to wait a little longer. January NYMEX crude fell $2.92 to $91.50 per barrel on Wednesday, after a smaller-than-expected drawdown in U.S. crude stockpiles. The Energy Information Administration reported that crude inventories dropped by 400,000 barrels in the week ending Nov. 23, less than one-third the 1.4 million barrel draw that had been forecast. Distillate inventories fell by 100,000 barrels, while gasoline stockpiles rose by 1.4 million barrels last week.

Among other stocks in the news Wednesday, Herman Miller (MLHR) shares rose 17.9% after it raised its second quarter EPS guidance to 56-63 cents (excluding a charge) on sales near or slightly above the top-end of previous guidance of $475-$500 million. The office-furniture maker also raised its long-term operating income target to 13% of sales.

CBRL Group (CBRL) posted first quarter EPS of 57 cents vs. 45 cents from continuing operations on 1.8% higher same-store sales at Cracker Barrel Old Country Stores, and 4.1% higher total sales. The restaurant operator sees 3% to 4% fiscal 2008 revenue growth, and $3.00-$3.15 EPS from continuing operations. Shares fell 4.1%.

QLT Inc. (QLTI) shares jumped 23.9% after it said its directors have formed a special committee to review all strategic alternatives available to the company, including transactions involving the sale of all or part of the assets of the company. (OSTK) shares climbed 14.7% on an upgrade by Stifel Nicolaus to a hold from a sell rating.

European stocks advanced Wednesday. In London, the FTSE 100 index climbed 2.70% to 6,306.20. In Paris, the CAC 40 index rose 2.34% to 5,561.21. Germany's DAX index gained 2.55% to trade at 7,723.66.

Major Asian markets finished mixed. Japan's Nikkei 225 index fell 0.45% to 15,153.78. In Hong Kong, the Hang Seng index added 0.59% to 27,371.24.

Treasury market

Bonds, which had rallied recently on perception the Fed would lower rates at the Dec. 11 meeting, moved lower Wednesday as stocks gained.

The 2-year Treasury note was off 06/32 to 100-27/32 for yield of 3.17%, 10-year notes fell 21/32 to 101-25/32 for a yield of 4.03% and the 30-year bond dropped 30/32 to 109-16/32 for a yield of 4.42%.

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