U.S. stocks to see more volatility next week Fed cut in discount rate leaves market hoping for more By Nick Godt , MarketWatch Last Update: 12:01 AM ET Aug 18, 2007 
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NEW YORK (MarketWatch) -- Stocks will remain volatile next week, although with more of an upbeat tone than in recent times, as investors weigh the effectiveness of the Federal Reserve's surprise cut of its discount rate, a move widely seen as an attempt to diffuse this summer's credit markets crisis, analysts said.
The central bank's key fed funds rate, which directly impacts short-term bonds, was left unchanged at its current level of 5.25%. "The move by the Fed [Friday] morning was important but it was largely symbolic," said Mike Malone, trading analyst at Cowen & Co. "It will serve to reduce volatility in the coming week but there is still a tremendous amount of uncertainty out there." On Friday, news that the Fed had cut the discount rate by 50 basis point inspired a "relief rally" that saw the Dow Jones Industrial Average Yet the rally wasn't enough to reverse steep weekly losses. The blue-chip average lost 1.2% on the week,fell 0.5% and the Nasdaq Composite "The one thing that [central bankers] showed is that they're flexible," Malone said. "In the event that credit markets would deteriorate further, it's now reasonable to assume that they would act and that helps to reduce the uncertainty and the volatility we've seen in recent weeks." "But we're not out of the woods yet," he said. "There is the potential for additional shoes to drop," or more bad news coming from financial institutions across the globe. Halting a very negative trend Volatile conditions and bad news at financial institutions first led markets to enter "official" correction territory on Thursday, with major indices having lost more than 10% from their July highs. The Dow fell 200 points on Tuesday, 167 points on Wednesday, and more than 340 points on Thursday before a late-day rebound. The Fed's move "definitely changes the mood, but it doesn't fix the problem," said Owen Fitzpatrick, head of the U.S. equity group at Deutsche Bank. "Challenges in credit markets and subprime markets remain," he said. "We have to see what additional fall-out there is from hedge funds or institutions trying to come to the market for liquidity." Before the Fed's intervention, the week was again marked by turmoil in credit markets and woes linked to subprime mortgages at big financial institutions. Countrywide Financial the largest mortgage lender in the nation, saw its shares slide 31% this past week, even after rebounding 13% on Friday. The lender drew down all of a $11.5 billion credit facility to fund its operations, saying that difficulty in raising money in credit markets was a potential threat to its business. Standard & Poor's cut its ratings on the firm, citing liquidity and earnings pressures. Other casualties of the credit crisis this week included Sentinel Group, a futures brokerage, which said it wouldn't allow clients to withdraw their money, as well as Thornburg Mortgage which said it wouldn't accept new lock-in requests for mortgages for four days. The week had started on news that Goldman Sachs had injected $3 billion in one of its troubled hedge funds. Real rate cut? While the Fed's move a seen a positive surprise by the market, "people will now probably place a high probability of a cut [in the Fed funds rate] in September," said Deutsche Bank's Fitzpatrick. The cut in the discount rate was "a band aid, but we still need to get to a point where credit markets are functioning properly," he said. Speculation over whether the central bank will really cut interest rates at its Sept. 18 meeting, or sooner, will have ample room next week, amid a dearth of economic data. The main economic news will come on Friday, when reports on July durable goods orders and new home sales will be released. "Expectations are that the Fed will lower rates at the next meeting in September and that will serve to limit volatility in coming weeks," said Cowen's Malone. "But I'm reluctant to say that the market will appreciate meaningfully next week." Watching the yen Investors will also closely monitor the Japanese yen, which rallied to a 14-month high against the dollar, in a move that led the Tokyo Stock Exchange to have its worst day in nearly six years on Friday. For Japan, a stronger yen threatens exports and its overall economic recovery. But for investors, a weak yen had been a symptom of a boom in liquidity that had helped boost financial markets and economies across the globe over the past few years. Investors would borrow yens at zero or near-zero interest rates in Japan to invest in high-yielding currencies and assets across the globe with virtually no risk attached, the so-called yen carry trade. But the current credit crisis and the repricing of risk has seen a reversal of that trend, and investors now fear that the yen carry trade has also stopped being a key source of liquidity for global markets. Earnings "Even though no one cares, earnings have been pretty good," said David Dropsey, senior research analyst at Thomson Financial. With 93% of S&P 500 having now reported, earnings growth in the second quarter is now pegged at 8.1%, a vast improvement from the 4.1% expected at the beginning of July. That still remains below the double-digit earnings growth that had been seen over the past few years. With the credit crisis completely absorbing the market's attention, investors haven't really been reacting to the overall results from earnings season. "It's been 100% trumped by the other news," Dropsey said. What still bears paying attention, however, is that the overall number of companies providing forward-looking guidance is substantially lower than last year and in previous quarters. Only 80 companies of the S&P 500 have provided guidance so far, compared with 130 at this time last year. And out of the roughly 6,000 companies tracked by Thomson Financial, only 432 companies have provided guidance, compared with 642 last year.