- The Washington Times - Tuesday, August 9, 2011

Wall Street stocks staged a convincing comeback after weeks of turmoil Tuesday, with the Dow Jones industrial average first plumbing new lows near 10,500 before surging to end up 430 points in a lightning-fast rebound in the closing 45 minutes of trading.

As investors sought frantically to find a bottom in stock prices, the Federal Reserve emerged from a daylong meeting with little solace for the markets, prompting the Dow to quickly lose more than 200 points, only to recover its bearings and make a dramatic comeback with a swing of more than 600 points by the end of the day.

“Despite all the dire news, stocks arguably look undervalued,” said Russ Koesterich, chief global investment strategist for BlackRock’s iShares business, reflecting the mood of buyers who came back into the market in droves when major stock indexes fell to levels about 15 percent below their highs of the year.

“Equity prices already reflect a very dramatic slowdown in the economy,” he said. “Yet, the combination of easy monetary conditions, a healthy corporate sector and declining commodity prices should be sufficient to keep the economy out of recession.”

The Dow appeared to find support from buyers at around 10,600, and rebounded by 4 percent to 11,240. The Standard & Poor’s 500 index of blue-chip stocks attracted support at around 1,100 and climbed back by nearly 5 percent to 1,172.

Markets in Australia, New Zealand and Japan opened higher Wednesday, continuing Tuesday’s rebound.

U.S. Treasury bonds continued to perform remarkably well in the wake of a first-ever downgrade of the U.S. credit rating, with the yield on 10-year bonds briefly descending to a record low of 2.03 percent as investors from around the world braced for anemic growth and continued to seek out safe havens.

Since 30-year mortgage rates are linked to Treasury bonds, that development, along with another big drop in oil prices to below $80 a barrel, promised to bring significant relief to consumers, businesses and investors whose confidence has been badly shaken by recent harrowing news on the economy.

“While markets may react negatively to the news of the downgrade and other global overhangs, the reality is the U.S. remains one of the safest and potentially rewarding investing options,” said Mark Feinberg of Feinberg Capital Advisors.

Still, the damage from the downgrade by Standard & Poor’s Corp. over the weekend was very real for stock investors worldwide, who have lost trillions of dollars of wealth.

“Although the direct impact of the downgrade has been minimal as yet, it has undermined market confidence,” said Aroop Chatterjee, an analyst at Barclays Capital, adding that the downgrade was an eye-opener because it “once again refocused the market on the potential for the ‘unthinkable’ becoming reality.”

S&P on Tuesday continued to issue downgrades of institutions and investments that rely for payment on the federal government, including debt issues backed by the Federal Housing Administration and other federal housing programs.

In an upbeat development, however, S&P said that some state and local governments with AAA ratings such as Maryland and Virginia may be able to preserve their top rating despite the U.S. downgrade from AAA to AA+ if they have managed their finances well and are sufficiently independent of the federal government.

Bank stocks, pummeled initially by the downgrade on fears it would undermine the financial health of banks, made a dramatic comeback Tuesday. Bank of America shares rocketed by 17 percent, recouping much of their 20 percent loss on Monday.

“The S&P downgrade of U.S. long-term debt will have limited direct impacts on financial markets and financial firms, in our view,” said Frederick Cannon, analyst at Keefe, Bruyette & Woods. “The U.S. economy remains flush with liquidity, so there is little immediate risk in funding markets.”

The downgrade torched confidence, however, and that will hurt the economy, he said. “What the economy lacks is consumer and business confidence.”

A statement from the Fed in midafternoon initially appeared to add to the unnerving news, although it was later credited with aiding the stock rebound. The Fed said that it would hold short-term interest rates near zero for at least another two years — an unprecedented commitment to such low rates.

But the Fed did not offer any new measures to aid the economy, triggering a plunge in stocks. While economic growth this year has been “considerably slower” than expected and “downside risks” to the economy have increased, the Fed said, it must remain vigilant against inflation as well as against higher unemployment.

Mr. Chatterjee said markets were initially disappointed because they were hoping recession worries would prompt the central bank to revive a controversial Treasury-bond purchase program it ended in June. But the Fed did not comply.

A split on the Fed’s rate-setting committee, with three hawkish Fed bank presidents voting against even the small but unprecedented change the Fed made in extending its period of rock-bottom interest rates, suggests that Fed Chairman Ben S. Bernanke would have an uphill fight to push another round of major easing through.

The Fed chose to try to calm markets with “dovish language,” Mr. Chatterjee said, in part because a report showing a pickup in hiring activity on Friday gave it “enough comfort” to stay on the sidelines.

Further, while markets have lost a good deal of value in recent days, from the Fed’s perspective, nothing like the “dislocations” that threatened to bring down the financial system in 2008 have occurred, he said.

Lance Roberts, chief strategist at Streettalk Advisors, said that while the Fed chose to stand pat on Tuesday, it likely will take further action in coming weeks if the economy continues to deteriorate, with the annual growth rate dropping below 1 percent or unemployment rising significantly above 9 percent.

“We have to remember that in the ‘30s, the government stood on the sideline as federal stimulus got drained out of the economy, resulting in the double-dip sequel to the Great Depression,” he said. Mr. Bernanke, who is an expert on the Great Depression, won’t want a repeat of that.