The Week Ahead: Confidence vs. Concern

After a horrid start to 2008, not to mention the past week, a combination of Federal Reserve action and federal government progress toward a fiscal stimulus package rejuvenated stocks. The Federal Reserve gave the market its first dose of medicine with its emergency action on Tuesday, as it cut the Fed Funds rate by 75 basis points (0.75%). However, by Friday, the market was already concerned about the risks that lie in the week ahead.

Last week, Treasury Secretary, Hank Paulson, and the Speaker of the House of Representatives, Nancy Pelosi, worked together to forge a fiscal stimulus package. In an election year, this should not be a surprise, since neither the Democrats nor the Republicans want to be viewed as indifferent to American economic weakness. The package, which still has to gain Senate approval, will basically provide Americans with $300 to $600, depending on income level, and $300 for each dependent child. Also, the first $6,000 of taxable income would be tax-free. Businesses will be allowed to deduct 50% of the cost of purchases of new equipment this year, encouraging business investment. While the Senate is rumored to want to add an extension to unemployment benefits and to increase food stamp distribution, the aid package is expected to pass quickly. However, checks may not reach Americans until after the IRS finishes with its regular tax responsibilities.

These two major events offered the stock market confidence that the government would support the economy as needed. The Federal Reserve continues to expect economic growth to moderate significantly, but many economists have increasingly pointed toward recession. Your author here has been forecasting recession for this period since early last year.

On Friday, market enthusiasm turned back to concern, and for good reason. Next week offers very important economic data and event risk. Perhaps the most important risk is tied to the result of the Fed’s two-day Federal Open Market Committee meeting (Jan. 29 – 30). Treasury yields are forecasting a further rate cut next week, but anecdotal evidence points to the possibility of Fed inaction on the 30^th. William Poole, President of the Federal Reserve Bank of St. Louis, reportedly voted against the emergency cut and indicated that the action could wait until the Fed’s regular meeting. This seems to imply the possibility of Fed inaction on Wednesday, but market pundits on financial news networks have mostly been forecasting further action.

Fed inaction would clearly disappoint the market. It’s hoped that the Fed understands the impact it could have, and might offer another 50-point rate reduction. I believe that even a 25 point move would be viewed as inadequate by the market, and lead stocks lower. The Fed is governed by two mandates, maintaining employment health and containing inflation, so there is no direct requirement for it to appease stock market concern, and thus the risk is born.

The president’s last State of the Union Address on Monday January 28^th was expected to carry with it the introduction of his fiscal stimulus plan, but with the bipartisan plan released this week, we see less likelihood of a positive catalyst from the president’s speech. We wonder if part of the speed of the package’s progress had anything to do with Democratic Party strategy, as preempting the president’s address minimized Republican benefit. There remains risk of the president bringing geopolitical issues back into the limelight again with discussion of Iran. Increased rhetoric could foretell the administration’s plans regarding the near nuclear nation.

The very important advanced reporting of fourth quarter GDP is scheduled for 8:30 EST on Wednesday morning, and Reuters estimates the economists’ consensus expectation for a very moderate 1.2% growth rate. This definer of recession carries with it the potential to raise hope, with a high reading, or increase concern, with a lower than forecast measure.

The week is full of important data, from December New Home Sales on Monday, to Durable Goods Orders (Dec.) on Tuesday to Personal Income & Consumption (Dec.) on Wednesday. The week also holds two separate reports on consumer confidence and six reports on employment. Of these reports, arguably the most important is Friday’s Employment Situation Report for January. In December, unemployment rose three-tenths of a point to 5.0%, waking up many to the rising probability of recession.

As earnings season kicks into high gear, related risk intensifies there as well. The reason for this is because, as analysts have lowered fourth quarter of ’07 estimates, they maintained ’08 expectations for mid-double-digit earnings per share growth. These expectations are probably ambitious, and corporate guidance is likely to be very conservative considering the economic situation. Thus, shareholder hopes are vulnerable for letdown.

Of the scores of companies reporting this week, a few that should be in focus include American Express (NYSE: AXP), Calamos Asset Management (Nasdaq: CLMS), Halliburton (NYSE: HAL), McDonald’s (NYSE: MCD), Tyson Foods (NYSE: TSN), Verizon (NYSE: VZ), Centex (NYSE: CTX), Eli Lilly (NYSE: LLY), Occidental Petroleum (NYSE: OXY), Robert Half Int’l (NYSE: RHI), Dow Chemical (NYSE: DOW), Traveler’s (NYSE: TLV), Yahoo! (Nasdaq: YHOO), Amazon.com (Nasdaq: AMZN), Evergreen Solar (Nasdaq: ESLR), Kellogg (NYSE: K), Kraft (NYSE: KFT), Merck (NYSE: MRK), Pulte Homes (NYSE: PHM), Starbucks (Nasdaq: SBUX), Anheuser-Busch (NYSE: BUD), Bristol-Myers Squibb (NYSE: BMY), Celgene (Nasdaq: CELG), Digital River (Nasdaq: DRIV), Electronic Arts (Nasdaq: ERTS), Google (Nasdaq: GOOG), Intuitive Surgical (Nasdaq: ISRG), Mattel (NYSE: MAT), Micros Systems (Nasdaq: MCRS), Monster Worldwide (Nasdaq: MNST), Proctor & Gamble (NYSE: PG), SEI Investments (Nasdaq: SEIC), Chevron (NYSE: CVX), Exxon Mobil (NYSE: XOM) and many more.

Disclosure: none