ADVISORY/ Ned Riley's Market Outlook: Stock Market Bottom Prerequisites -- Act III.

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What: Ned Riley's Market Outlook: Stock Market Bottom Prerequisites -- Act III

Who: Ned Riley is chief investment officer at BankBoston. This week, Ned's market outlook is a follow-up to his comments from last week.

-- Thursday's preemptive move by Fed Chairman Alan Greenspan took the financial community and markets by surprise. November 17 (the next FOMC meeting) looked like the appropriate time to implement the gradualist rate-cut strategy we've grown accustomed to over the past decade. However, the 25 basis point cut in the Discount and Federal Funds Rate now brings us to the level we felt necessary to render some credibility to a Fed easing strategy. All year long we have been advocating ease, and now we are getting some meaningful movement.

Does this mean that the worst is behind us? In some areas, the answer is a resounding yes. For example:

--The global financial crisis is getting some desperately needed amoxicillin to combat infection that has spread throughout emerging and developed countries. A lower rate structure in the U.S. has prompted other countries -- such as Canada, the United Kingdom, Spain, Portugal, Japan and other monetary bodies -- to follow suit. Japan has decided to address and resolve its banking crisis, easing the region's credit strains. A stronger yen and weaker U.S. dollar have eased the pressure on Brazil's real and Hong Kong's peg. These agressive moves by Chairman Greenspan have sent a clear signal that he wants to prevent a seizing up of the credit delivery system. Our forecast for additional easing of 50 basis points before year-end remains in the scenario. The Fed recognizes that increased confidence in financial markets is an essential ingredient for a healthy banking system.

--Last week, we stated that the financial stocks, particularly banks, were discounting the most dire of circumstances. We are encouraged that most money centers and regional banks have made heroic recoveries from their dismal lows. In my October 7 commentary, I said "Look for this group to be the first to bottom, and the first to outperform on the upside." This has happened.

--Lower rates may loosen the purse strings of investors in money market accounts. A 50 basis point reduction in yields may be sufficient to move some of the $1.3 trillion tucked away in money market funds. However, I do not expect a wholesale liquidation of money market funds or aggressive moves toward increasing equity allocations in 401(k) plans. Quiescent behavior of this group during this tumultuous period may be confirmation that they have actually embraced the concept of long-term investing. Ad hoc decision making may not be prominent in this cycle. The ultimate capitulation we have been expecting from, this group may become a lower probability.

--Easing moves may mitigate a macro impact on the real GDP and consumer spending in the U.S. However, the die is still cast for weak profits, layoffs and restructurings. Adverse news relative to profits should continue to dominate the next several quarters of shareholders' reports. The question of how much the market has discounted these earnings shortfalls will be debated more than once over the next several months. one thing is certain: a declining trend in corporate earnings will keep a lid on the upside potential of share prices.

Things that will remain the same after the Fed easing:

--Weak profits, restructuring and layoffs will keep investors guessing shorter-term. --Valuation has remained extreme for the Internet stocks and some healthy sectors of the market, such as software companies and drug manufacturers. --The demand for equity mutual funds remains soft. The case for increasing equity exposure in 401(k)s will be dominated with uncertainty and doubt.

Conclusion

This recent Fed move was a welcome relief and produced a magnificent Rolaids rally. This week's market activity may reflect certain doubts that portfolio managers and investors have about the motivation behind the midstream easing. We would like to declare that this marks the end of our long-awaited correction. As far as I'm concerned, many sectors of the market have seen their lows. However, it is a bit premature to recommit the reserves which were sidelined last spring, prior to a reduction in equity ratios. However, this is not the type of environment for investors to stray far from our existing strategic allocations.