Fed decision on rate cut to decide course of market

Fed decision on rate cut to decide course of market

This week the golden rule of the stock market “buy on rumor; sell on fact" will be put to test once again. So far, history shows that this rule has proved true. Investors are on tenterhooks over the outcome of the meeting of US Federal Reserve, scheduled for Tuesday. There is uncertainty over what the Fed will do.

Markets across the world have discounted a 25 basis point cut in fed rates. The movement of short-term interest rate futures on Friday indicates that investors believe a 50 basis point cut in the federal funds rate is more likely. However, going by facts, I expect that the Fed might cut the federal rate by 25 basis points and the discount rate by 50 basis points.

If the Fed cuts the federal funds rate by 25 basis points, then the markets will fall. However, what would be more important will be to see what stand the Fed takes on its future course of action.

If the Fed hints at more cuts to come, then the fall on global bourses could be a short-term phenomenon and the speculation will begin again over the outcome of the next Federal Reserve meeting.

If the rates are cut by 50 basis points, then the markets may see an initial spurt, followed by a spate of selling as the market may conclude that the problems in the US are much bigger than expected.

Moreover, a 50 basis point cut could mean a further weakening in the dollar (the currency is already near its 15-year low). That might start another crisis on global bourses. So, even a 50 basis point cut may not go down well.

This week, four leading investment banks, Lehman Brothers, Morgan Stanley, Bear Stearns Cos. Inc. and Goldman Sachs Group Inc. will declare their third quarter earnings. The numbers will be watched carefully as this will give an insight into the impact of the subprime mortgage crisis on the financial health of these companies and also on the credit markets.

On Friday, US stock markets ignored a warning by Merrill Lynch that revived concerns about credit conditions and the impact of the weak US housing market. Merrill Lynch & Co Inc said it has adjusted the value of securities linked to risky subprime mortgages and that the move could hurt its third quarter profits.

Earlier, news that Northern Rock of Britain, which originates subprime loans for Lehman Brothers received an emergency loan from the Bank of England and issued a profit warning rocked European bourses and led to a fall in the US markets. The subprime crisis is not yet over and there may be more casualties.

My call is to wait and watch. I see a fall in global bourses following the Fed meeting; in the the best possible situation, there could be an upside lasting a day or two, following which there could be a fall. This is a subjective call and I’d advise investors not to go short.

Big Tuesday in India

The Indian markets will move on global cues and the outcome of the Fed meeting will be important. However, things are looking quite good for India with inflation falling further. The stage is set for the reduction of interest rates down the line. It appears that Indian markets may outperform their global peers and buck the severity of trend if the global markets fall.

Technically, on its way up, the Sensex may witness resistance at its all time high level of 15,868.85 points. If this level is breached, then the Sensex may scale past 16,000 points to touch a high of 16,098, the next resistance level. A comfortable close above this level would mean a rise to 16,334 points. However, on the downside, the Sensex may see its support around 15,500 points, with the next support at 15,398 points, then, 15,023.

This week, Larsen & Toubro Ltd, Maruti Udyog Ltd and Patel Engineering Ltd look good on charts. Larsen & Toubro, at its current market price of Rs2,591, has a strong resistance at Rs2,630. If it closes above this level then it may touch Rs2,700 with a stop loss of Rs2,530. Investors may note that this is not a typical weekly recommendation and may extend beyond this week.

Maruti Udyog, at its last close of Rs869, has a target of Rs898 and Rs922 with a stop loss of Rs840.

Patel Engineering, now trading at Rs451, has a target of Rs482 with a stop loss of Rs421. From our last week’s recommendations, Bharti Airtel Ltd recommended at Rs847, touched a high of Rs860, but fell later on profit selling. Tata Power Ltd recommended at Rs718, touched a high of Rs761 on BSE and met its target of Rs742.

Vipul Verma is a Delhi-based investment advisor. Your comments, questions and reactions to this column are welcome at ticker@livemint.com