CNNMoney.com ~ Stocks succumb to bleak Fed outlook

Wall Street erases most of the session’s gains that followed the Federal Reserve’s interest-rate cut.

By Alexandra Twin, CNNMoney.com senior writer

Last Updated: October 29, 2008: 4:14 PM ET

NEW YORK (CNNMoney.com) -- A stock rally fizzled out by the close Wednesday as investors were cautious after the Fed cut interest rates, as expected, and acknowledged the depth of the economic slowdown in its statement.

The Dow Jones Industrial average (INDU) lost about 74 points, according to early tallies, after having risen as much as 298 points in the last half hour of trade.

The Standard & Poor’s 500 (SPX) index lost 1.1%, erasing earlier gains. The Nasdaq composite (COMP) gained 0.5%, erasing most of its gains.

The major gauges had gyrated wildly in the minutes after the release of the Fed decision and statement, before turning higher in the last hour of trade.

Policymakers voted to cut the fed funds rate by half a percentage point to 1.0%, as expected. That matched an all-time low for the fed funds rate last seen in June 2004. The fed funds rate is a bank lending rate that impacts business and consumer loans. (Full story)

The stock and bond market reaction was muted because investors had been expecting a cut of at least a half-percentage point, said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. However, he noted that "the statement had a little more meat on it than it usually does."

Fed cuts rates: In its closely scrutinized statement, the central bankers acknowledged the downturn in the economy is due partly to a big drop in consumer spending. "The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures," the statement read.

The Fed also acknowledged the impact of the financial market crisis on lending, with the bankers noting: "Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."

Shapiro said that a reader of the statement who didn’t know the fed funds rate was already at 1% might think the central bank was trying to signal future rate cuts. However, he said it’s that with rates so low, the Fed is likely to just hold steady for a while and continue "throwing the full arsenal" at the financial crisis and the economy, as it has been doing.

The Fed has been cutting the rate for more than a year in an effort to recharge the stalling economy. The Fed has also made potentially trillions available to financial institutions in an attempt to calm roiling financial markets and get banks to start lending to each other again.

On Tuesday, the Dow surged 889 points - its second-best, single-day point gain - as investors scooped up shares hit in the recent retreat. In percentage terms, the advance of 10.9% was the sixth largest ever. The S&P 500 jumped 10.8%, and the Nasdaq composite jumped 9.5%.

Market breadth was positive. On the New York Stock Exchange, winners beat losers three to one on volume of 1.14 billion shares. On the Nasdaq, advancers topped decliners five to two on volume of 2.17 billion shares.

Lending rates: Meanwhile, the credit market continued to improve, with Libor, the overnight bank-to-bank lending rate, falling to 1.14% from 1.24% the previous day, according to Dow Jones. The 3-month Libor fell to 3.42% from 3.47%. (Full story)

The TED spread, the difference between what banks pay to borrow from each other for three months and what the Treasury pays, widened to 2.81% from 2.71% Tuesday. The spread hit a record 4.65% earlier this month. The narrower the spread, the more willing banks are to lend to each other.

The yield on the 3-month Treasury bill, seen as the safest place to put money in the short term, slipped to 0.57% from 0.75% late Tuesday, showing investors would rather see little return on their money than risk the stock market.

Last month, the 3-month yield reached a 68-year low around 0%, as investor panic hit its peak.

Treasury prices slipped, raising the yield on the benchmark 10-year note yield to 3.86% from 3.84% late Tuesday. Treasury prices and yields move in opposite directions.

Economy: Ahead of the Federal Reserve decision, investors mulled a better-than-expected durable goods orders report.

The Commerce Department said new orders for big-ticket items - including cars and appliances - rose 0.8% in September versus forecasts for a drop of 1.1%. Orders fell a revised 5.5% in August.

Results: A variety of companies were reporting quarterly results as the third-quarter reporting period hit its midpoint.

Dow component Procter & Gamble (PG, Fortune 500) reported higher quarterly sales and earnings in its fiscal first quarter, topping estimates. However, the consumer-products maker also said that full-year earnings could be weaker than previously expected. P&G fell 1.7%.

Fellow Dow component General Motors (GM, Fortune 500) reported a steep drop in global third-quarter sales, with North American sales down 19% versus a year ago.

GM was also the subject of reports that it could ask Toyota Motor for help in turning around its business. GM declined to comment on the reports. Shares of GM rose 9%.

Another Dow component, Kraft Foods (KFT, Fortune 500), said third-quarter profit more than doubled due to a one-time gain resulting from its $2.6 billion sale of the Post cereals unit.

With roughly 52% of the S&P 500 results out, profits are currently on track to have fallen 23.9% versus a year ago, according to the latest data from tracking firm Thomson Reuters.

Other markets: The dollar tumbled versus both the euro and the yen.

The weakness in the U.S. currency helped propel dollar-traded commodities.

U.S. light crude oil for December delivery rallied $4.77 to settle at $67.50 a barrel, as investors reacted to the weaker dollar and the weekly oil inventories report. That report showed a smaller-than-expected buildup in crude supplies. Oil prices ended the previous session at a 17-month low.

COMEX gold for December delivery rallied $13.50 to settle at $754 an ounce.

Gasoline prices fell another 4 cents overnight, to a national average of $2.589 a gallon, according to a survey of credit-card activity by motorist group AAA. It was the 42nd consecutive day that prices have decreased. During that time, prices have fallen by $1.26 a gallon, or nearly 33%.

A brutal month: Despite Tuesday’s big rally, October is still shaping up to be one of Wall Street’s worst months ever.

As of Tuesday’s close, the Dow had lost 1,785 points, or 16.5% in October. Barring a massive rally over the next few sessions, the point loss will amount to the Dow’s worst ever, according to Stock Trader’s Almanac info going back to 1901. On a percentage basis, it doesn’t rank in the top ten.

The S&P 500 has lost nearly 226 points, or 19.4%, and is currently on track to post its worst month ever on a point basis and eighth worst ever on a percentage basis, going back to 1930.

The Nasdaq was down 433 points, or 20.8%, tracking it’s seventh-worst month ever on a point basis and its fifth-worst month on a percentage basis, going back to its inception in 1971.