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All eyes on Fed following free fall

Analysts say it has the best tools to help stage an economic rebound

NEW YORK — The stock market ended one of its worst weeks in history on Friday with all eyes focused on Tuesday's meeting of Federal Reserve policymakers in Washington.

With the sell-off sending all major stock indexes down more than 6 percent for the week, hopes have quickly faded among analysts that the markets and economy will snap back quickly. But the Fed, with its ability to cut short-term interest rates, still has the best weapon at hand to engineer a rebound, they say.

Friday marked the third sharp decline this week. The NASDAQ composite index, heavy with technology issues, finished below 1900. The Dow Jones industrial average, having fallen below 10,000 earlier this week, dropped below 9,900. It was the Dow's worst week since October 1989 and the broader Standard & Poor's 500-stock index's worst week since April last year.

The Federal Reserve will not come out and say that it is trying to help the stock market if it does what everyone assumes it will do on Tuesday and cuts short-term interest rates for a third time this year.

But if the past is an accurate indicator of future performance, the Fed will lower borrowing costs and the market will rise. What is less clear is whether the gains will be large and enduring; recent experience is not encouraging.

The consensus on Wall Street holds that the Fed will cut its target on overnight bank loans by at least half a percentage point. That move would follow similar half-point reductions on Jan. 3 and Jan. 31.

"A third cut usually convinces the market that the Fed really wants a recovery," said Edward Yardeni, chief investment strategist at Deutsche Banc Alex Brown. "On Wall Street there is a saying, 'Don't fight the Fed.' But for the last week or so people have been wondering if the Fed is fighting hard enough for them."

The week's free fall has confirmed, by Wall Street's definition, the arrival of the first bear market since 1987.

Slowing economic growth in the United States, despite a few positive signals, and sharply declining corporate earnings are weighing on stocks. The financial and political crisis in Japan, the world's second largest economy, is threatening to become a drag on global economic growth.

In Europe, growth forecasts are also slipping as signs of rising inflation delay the European Central Bank's expected cuts in interest rates. That delay helped send the euro down 3.7 percent against the dollar this week.

"Why aren't investors becoming more upbeat about the economy?" asked Hugh Johnson, chief investment officer at the First Albany Corp. "They should be." Despite the likely Fed rate cut on Tuesday and a federal tax cut in the works, investors he talks to expect no recovery in the economy or corporate earnings for the rest of the year, he said, adding, "That's very troubling."

Douglas R. Cliggott, chief equity strategist at J.P. Morgan, said that the investors he talks to around the country are also becoming pessimistic about the longer term. Instead of just wondering whether there will be a recession or how soon to jump back into stocks, they are questioning whether earnings growth will again be as strong as in 1999 and most of 2000.

"There is a growing sense that we could be in a period of years when earnings per share growth could be much slower than in previous years," Cliggott said.

This pessimism is fed by a barrage of bad earnings news. Analysts' current earnings forecasts for the companies in the S&P 500 index are for declines of 6.3 percent in the first quarter and 4.1 percent in the second quarter, a sharp reversal from earlier forecasts that predicted 5 percent growth in each quarter.

Many investors appear to expect a cut of three-quarters of a percentage point by the Fed in its benchmark federal funds rate, the overnight rate on loans between banks. Many analysts, however, still think the Fed will cut rates by one-half of a percentage point.

Investors want the Fed to cut interest rates deeply and quickly to turn the economy around and once again make stocks attractive. But even if the Fed cuts rates Tuesday by only half a point, it will be Alan Greenspan's fastest series of cuts since he became Fed chairman in 1987.

Contributing: Kenneth N. Gilpin, New York Times News Service