Fed seen cutting rates again

Third-quarter GDP likely to show contraction

Stocks will start the coming week with weary investors hopeful that a wave of selling in markets around the world will either abate or reach a climax, while reports are expected to show the economy contracting for the first time since 2001.

“There’s no question there remains a lot of volatility and that we could see much bigger declines ahead given all the deleveraging by funds that’s taking place,” said Hugh Johnson chairman of Johnson Illington Advisors.

Worries that the global economy is sliding into recession last week spurred massive dollar repatriation and fueled so-called deleveraging — when investment funds scramble to raise cash to repay money borrowed to make investments that went wrong.

Oil and commodities were the hardest hit, with crude oil futures sliding 11% in one week to finish below $65 a barrel.  Energy and materials stocks led broad declines in U.S. stocks, which slumped more than 5% for the week.

Amid a flurry of economic reports next week, investors will especially look to the first reading of the third-quarter gross domestic product, which is expected to confirm the economy contracted by 0.5%, according to the median forecast of economists surveyed by MarketWatch.

The Federal Reserve, which meets on Tuesday and Wednesday, is widely expected to again cut interest rates to try and provide a boost to the ailing economy. Futures traders gave more than 100% odds that the central bank will cut its target rate by half a percentage point.

“Next week, the focus will be on the economy, earnings, and the Fed, along with short-term credit conditions and stock markets around the world,” Johnson said. “We’ve got to watch everything.”

Cash is king

The past week had started on a hopeful note that stocks had stabilized, with the Dow industrials rallying more than 400 points Monday as Federal Reserve Chairman Ben Bernanke backed more fiscal stimulus to boost the economy.

Government plans to re-capitalize ailing banks around the globe had helped stocks rise the previous week, as inter-bank lending showed signs of life. But it wasn’t long until more economic reports from Europe and Asia rekindled concerns that the U.S. won’t be alone when its economy goes into recession.

The Dow ($INDU) slumped more than 500 points on Wednesday, and after a brief respite Thursday, it joined a sell-off in Asian and European stock markets Friday to lost another 312 points and finish the week at 8,378.

For the week, the blue-chip average lost 5.3%, while the broad S&P 500 index ($SPX) fell 6.8% and the Nasdaq Composite ($SPX) plunged 9.4%.

Bottom holds

Some market strategists remain hopeful that the worst of the downdraft in stocks might be behind, even as they predict volatile conditions to remain in place for the foreseeable future.

On Friday, futures for the Dow industrials were halted after they plunged more than 550 points as global markets skidded. Some in the market hoped for the market to experience capitulation, when selling first reaches a climax that eventually leads to a bottoming out process.

While Friday wasn’t that day, some investors believe the move could be seen next week.

“The deleveraging process has put pressure on markets, but sellers will exhaust themselves at some point,” said Owen Fitzpatrick, head of U.S. equities at Deutsche Bank. “You need a buyer at the end of the day but the [selling] has to become more severe than what we have now to get the buyers in.”

Other strategists, such as Johnson, believe market lows were already made after near-panic selling on Oct. 10, when the Dow plunged to an intraday low of 7,773.

“The worst for the stock market may be behind, even as the worst for the economy remains ahead,” Johnson said. “The market has already discounted a very gloomy outcome for the economy and earnings. I have my fingers crossed that ‘gloomy’ is the right word and that it won’t get much worst than that.”

Besides the GDP on Thursday, data on new home sales in September will be released on Monday and on home prices and consumer confidence on Tuesday. The Fed decision on rates is expected Wednesday, along with be a report on orders for durable goods. This will be followed by weekly jobless claims Thursday, and on Friday, a key inflation reading, and data on manufacturing in the Chicago region.

Earnings

Financial results for the S&P 500 companies, including the 245 that have already reported and analysts’ estimates for the rest, are on track for 21% decline in the third quarter, according to FactSet Research.

Such a drop would mark the fifth straight period corporate earnings have contracted from the year-ago period.

Next week brings another peak week for earnings, with 123 S&P 500 companies reporting. Those Dow components Verizon (VZ) on Monday, Procter & Gamble (PG) on Wednesday, Exxon Mobil (XOM) on Thursday, and Chevron (CVX) on Friday.

But investors are now mostly concerned with the outlook for earnings, and even though the fourth-quarter has an easy comparison to last year’s — which already reflected the impact of the credit crisis — forecasts are now coming down fast.

“Analysts are cutting estimates across a broader array of sectors,” said Thomson earnings analyst John Butters. And that’s not just in financials but also in the energy, industrials, materials, technology and telecoms sectors.”

 

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