The Stocks That Will Eventually Suffer the Most from the Fed’s Inaction

Nasty. That’s the only word to describe the stock market’s reaction yesterday to the U.S. Federal Reserve’s meager quarter-point interest-rate cut. The S&P 500 was down 2.5%, the Dow Jones Industrial lost 2.1%.

The market wanted deeper rate cuts Tuesday and the Fed simply didn’t deliver. While interest-rate futures bets showed a 40% chance the Fed would cut rates half a point, my feeling is that most economists were expecting the half-point cut. In fact, one well- known, large U.S. financial institution had been predicting a cut of three quarters of a point. Most people I talked to last night in the financial arena thought that the Fed just didn’t act.

Maybe former Fed Chairman Greenspan spoiled the market — always delivering what it expected. Bernanke, who I thought at first was simply following Greenspan’s act, is obviously not so keen to keep Wall Street happy all the time. Could Bernanke be saying, “Hey, I’ve already cut rates by a full point since September. If I keep cutting rates too aggressively, I won’t have any ammunition left in the economy rally tanks.”

As the U.S. Federal Reserve failed yesterday to deliver the half- point cut in interest rates the market was looking for, the Dow Jones U.S. Home Construction (comprised of the largest U.S. homebuilders) plummeted 9.8% in one single day. What this tells me is that, after President’s Bush’s bailout attempt of over one million subprime mortgages, the stock market was expecting the Fed to help bail out the homebuilders, too.

I’ve been following the markets for more years than I care to remember and I’ve never seen a major index fall almost 10% in one day without further aftershocks not being far off. One comfort: the Fed said yesterday that the housing market is getting worse. You’re kidding?

When I started writing in 2005, most of the young crowd on Wall Street had no idea how a housing bust could affect the stock market. But it is all very simple: Most homebuyers in the U.S. do not have equity in their homes to weather a housing market downturn like the one we are experiencing right now. Having your home fall in value as the mortgage stays the same is not the best mental state to be in… it actually works to halt consumer spending.

As consumers get tighter in the wallet, they spend less, and that affects the economy and affects the stock prices of the companies that make and sell goods into the economy. The real blow dealt by the lack of more aggressiveness on the part of the Fed yesterday, in my opinion, will be to the big-cap stocks — most of which suffer during consumer spending cutbacks. This is a group of stocks I won’t touch with a 10-foot pole right now.

NEWSFLASH — Freddie Mac, the second-largest U.S. mortgage company owning or guaranteeing one in five U.S. home loans, said yesterday that defaults on mortgages it owns or guarantees are rising to a record level. The company’s CEO told guests at a conference yesterday that the housing market in the U.S. would get tougher before better. Thanks for the insight.