In a surprise move, the Fed cut the federal funds and discount rates by 50 basis points each this afternoon. I think most folks, including ourselves, were hoping for 25 basis points but fearful that they might actually do nothing. So, this is definitely a surprise in our books. The markets are clearly happy with the S&P at this moment up 2.3% and the Dow up 1.9%.
Theoretically speaking, when rates go lower, multiples should expand. And like zero coupon bonds, companies that pay little or nothing in the way of dividends often see the most in terms of upside price action. Of course, that is how the theory goes and stocks are clearly moved by factors other than just rates, unlike no risk government bonds.
This move signals that a shift in market leadership is likely at hand. The Fed is officially acknowledging with this move, that a slowdown in domestic economic growth or momentum is at hand, which outweighs the risks of inflation. In periods like this new environment, growth usually begins to sell at a premium as it is "scarcer" to come by. Of course, where one finds growth changes from decade to decade, but where it exists, it usually increases in value.
It will be interesting to see how things settle down in a few days. For now, we're seeing a great rally and for those that are invested, this is good news. We wouldn't be surprised, however, if the markets get a slight hangover in a few days as folks realize that the Fed's moves can't fix troubled areas overnight. For housing and subprime lending, the issues will take alot longer to workout, just as it did for technology in the early part of this decade. There are no free lunches, after all.
But for now, this is good news and a welcome start in the right direction.