Market Outlook: 01-30-08

Robert Hsu, January 30, 2008

Sensing potential economic weakness, the Fed cut both the federal funds rate and the discount rate by 0.5%. The Fed cut more than the modest 0.25% that most investors were expecting. This puts the funds rate at an even 3.0% and the discount rate is down to 3.5%, marking the lowest interest rate level since 2005.

As you know, this move comes only one week after a three-quarter point cut on January 22. So what is the Fed trying to accomplish with all these cuts? The Fed wants to help financial services firms that borrow at short-term interest rates and lend out at long-term interest rates, like banks, make money again. Many of these firms suffered tremendous losses from originating, packaging and/or buying bad mortgage loans. In addition, the Fed wants companies and individuals to borrow more money and give the economy the shot in the arm it needs to get back on the growth track.

Now that we know what happened and why, let's talk about the real story here. If you look at the major U.S. market's performance last week, the S&P 500 had its first up week of the year. The index climbed 0.4% and the Dow added 0.9%. This move up is largely credited to the rate cut that came last Tuesday. Thanks Ben, but these cuts are like throwing kerosene on a fire -- sure it'll burn white hot, but it's very short-lived. Almost immediately after cuts like these the desired effects have been priced into the market. This is one reason why I'm going to remain cautious in the coming months and why I urge you not to chase this "rally."

Ultimately, I think that the S&P 500 Index will get trapped in a 10% trading range between 1270 and 1400 in the coming three months -- that's not a place you want to get stuck with an over-weighted portfolio. Smart investors should use this week's rally to lighten up and move money to non-U.S. dollar-denominated assets like gold and foreign securities.

Finally, if you're not convinced that the Fed's cut is not the magic pill the economy needs, here's something else to consider: Though the cuts will help financial firms make money, they will also create incredible downward pressure for the U.S. dollar. Before you start worrying, a weaker U.S. dollar is actually helpful to many companies that operate in foreign currencies.

Because of the U.S. trading range that I expect for the next three months and higher overall market risk, investors need to be more opportunistic in order to make money in the current environment. If you plan to do any buying, it's important to only purchase stocks with positive near-term catalysts. Want to know the best stocks to make money in the current environment? Become a subscriber of Asia Edge to invest in my top picks. I have a new stock for you this week with a strong potential catalyst, but before we get to that, let's do a quick check of the Asian markets.

Asia Benefits from the Fed

Last week, Asian stocks managed to recover most of their recent losses. The MSCI Asia Pacific Index closed at 145.73 -- after a 10% rally spurred by the U.S. Federal Reserve's 75 basis-point emergency interest-rate cut last Tuesday.

Also, both China and South Korea reported strong GDP numbers recently. China's economy expanded 11.2% in the fourth quarter, supporting global growth as a recession looms in the U.S. In 2007, China's GDP grew 11.4% from a year earlier, the fastest pace in 13 years, to 24.7 trillion yuan ($3.4 trillion). The country accounted for 17% of global growth, the same as the U.S., and is poised to overtake Germany as the world's third-biggest economy this year.

South Korea's fourth-quarter economic growth was a bigger-than-expected 1.5%, driven by the largest increase in exports in four years and a pickup in business investment. The growth rate accelerated from the previous quarter's 1.3%. Exports surged 7.3% in the fourth quarter, the biggest increase in four years.

In 2007, South Korea's economy advanced 5.5% from a year earlier, the fastest pace in almost two years. South Korea's increasing trade with China and Asia is helping it become less affected by a slowing U.S. economy. In fact, China surpassed the U.S. in 2003 to become South Korea's largest export market, buying more than 21% percent of the nation's exports. This month Goldman Sachs lifted its forecast for South Korea's economic growth to 5% this year.

Despite the positive economic news in these countries, both the Chinese and South Korean stock markets are still weak. Both the Mainland Chinese A-Share Index and the South Korean Kospi Index are down 16% for the year. Despite strong growth in South Korea and China, economies around the world are all vulnerable to a global recession led by the U.S.

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