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Fed cutting. Stocks sinking. What gives?

Equities are sharply lower since the Fed began its recent series of rate cuts in September, making this the worst reaction to an easing cycle since the 1950s.

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By Alexandra Twin, CNNMoney.com senior writer

Issue #1
  • This week at 12 pm ET, CNN explains how the slumping economy affects you.
  • Bailout backlash
  • Retail jobs on the chopping block
Has the federal government taken the necessary steps to turn the economy around?
  • Yes
  • No

NEW YORK (CNNMoney.com) -- Despite five interest rate cuts in the past six months, Wall Street has remained impervious to the Federal Reserve's wooing, with investors taking a "thanks, but..." attitude to Ben Bernanke & Co.'s attempt to recharge the economy and stock market.

Since September, the central bank has lowered its federal funds rate, a key overnight bank lending rate, to 3% from 5.25%, including a 75 basis point emergency cut in January. There are 100 basis points in one percentage point.

Federal Reserve policy-makers meeting Tuesday are expected to cut rates by as much as another 100 basis points, to 2%. Coincidentally, today's Fed meeting also marks the six-month anniversary of the first cut in this easing cycle.

But before you order your flowers and candy to send to your favorite central banker, it's worth pointing out that the stimulus from the Fed has done little for the stock market.

Since the first rate cut on Sept. 18 of last year, through Monday's close, the S&P 500 is down 16%. That makes this the worst performance for the market following a series of rate cuts since the 1950s, according to Standard & Poor's research. And that's taking into account other times when the economy was in a recession, as seems to be the case now.

Wall Street after rate cuts

S&P chief investment strategist Sam Stovall looked at where the market stood six months after the Fed initiated a series of interest-rate cuts, going back to the 1954 cycle.

Stovall found that the S&P 500 was in positive territory 7 of 11 times, for an average gain of 12.3% overall and a gain of 7.6% since 1980. For the years before 1980, Stovall looked at cuts to the discount rate and for the years after that, he looked at cuts to the federal funds rate.

How about the Nasdaq? Stovall looked at the tech average going back to its inception in 1971, again switching from the discount rate to the fed funds rate after 1980. On average, the Nasdaq rose 4 out of 7 times, for an average of 15.6% overall, and 11.5% since 1980.

Since the first rate cut last year, the Nasdaq is down almost 18%. That's the worst response since the 1990-1991 recession, when six months after the first rate cut, the Nasdaq was down 22.6%.

As for the Dow, Ned Davis Research looked at statistics going back to 1921 and found that the Dow also posted double-digit gains, on average, six months after the first in a series of rate cuts. The Dow rose 13 out of 18 times, for an average of 11.7%.

Since the first rate cut last year, the Dow is down 13%, the worst response since 1932, when the Dow had posted a loss of 37.5% at the six-month mark.

One of the reasons stocks haven't seen a 'Fed bounce' is that "although the Fed has been cutting rates for months, the economy hasn't started coming back yet," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research.

In fact, the economy has deteriorated since the September rate cut. The most recent reading on fourth-quarter GDP showed anemic growth of 0.6% and the first quarter is expected to show a contraction in growth, some economists say. Employers made the biggest monthly job cuts in February in five years. And pretty much every housing market report shows falling prices, lower sales and rising rates of foreclosure.

Did we mention that quarterly earnings are at a five-year low and that the dollar is plunging? And that oil and gold prices are at or just below record highs? And that Bear Stearns, one of the most venerable financial institutions on Wall Street, just sold itself for a fraction of its value amid the credit market collapse?

All of this speaks to the possibility that the Fed may have waited too long to start cutting rates, therefore muting the impact, said Scott Armiger, portfolio manager at Christiana Bank & Trust.

He said that stocks initially bounced a bit after the first cut, leading to record highs for the Dow and S&P 500 in early October and to a multi-year high for the Nasdaq around the same time. Stocks also got a bit of a jolt after the Jan. 22 surprise rate cut.

But beyond those short spurts, stocks have been on the slide.

"We didn't get a real Fed bounce because it was just too late," Armiger said. "By the time they started cutting, the consumer was already tapped out."

Meanwhile, banks haven't been using the extra liquidity as a means of expanding their borrowing capabilities.

"The problem is not one of liquidity, but solvency," said Ryan Atkinson, market analyst at Balestra Capital. "The Fed is providing liquidity, but assets are overvalued. With the amount of credit outstanding, real economic activity cannot support the cash flows needed to service that debt."

So what really might be needed before the market reacts favorably to the Fed cuts is more time.

Play it like it's 2002

Along those lines, the 2008 stock reaction to the Fed cuts could be similar to what happened in 2001-2002, when the Fed cut rates aggressively to stimulate the economy amid the end of the tech boom, 9/11 and the 2001 recession. The stock reaction to that was delayed, but ultimately positive.

"There's no doubt that we're in a financial crisis," said Bill Stone, chief investment strategist at PNC Financial Services Group. "But its also reasonable to figure that we could see a turnaround like in 2002."

The Fed cut rates 11 times in 2001, from 6.5% to 1.75%. But six months after the first rate cut, the S&P 500 was down 3.6%, the Nasdaq was down 6.2% and the Dow was down 4.3%, with Wall Street smack in the middle of a three-year bear market.

Stocks didn't bottom until October 2002 and didn't see an up year until 2003, a big year on Wall Street in which the Nasdaq rose more than 50% and the Dow and S&P 500 each gained more than 25%.

Stone's not saying that stocks are in for a year like that next year, as problems in the housing and financial markets are bound to linger. But eventually, he said, the markets start discounting the bad numbers and looking forward. And that will coincide with signs of a bottoming in the economy and other indications of a turnaround, all of which will be bolstered by the Fed's cuts.

So while the market may not be feeling any better six months after the first rate cut, it may be a different story another year from now. To top of page

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