Stocks Close Lower After Fed Rally Fizzles

A stock rally fueled by the Fed's latest interest rate cut lost momentum in the final hour after CNBC reported that two big bond insurers could be downgraded as early as today.

The market soared after the Federal Reserve announced a half-point interest rate cut,  as expected, and suggested more cuts are possible.

But the market quickly turned negative after CNBC reported that Wall Street bond rating agencies could downgrade two big bond insurers, Ambac Financial Group and MBIA, even though New York state insurance regulars would like to get a postponement until the state can develop a bailout package.

"Fear that U.S. bond insurers Ambac and MBIA will be downgraded by ratings agencies was a catalyst," said Action Economics.

Losing a Triple A rating could be devastating for the bond insurers, preventing them from drumming up new clients -- and possibly forcing them out of business.

Insurer Ambac has received a downgrade from rating agency Fitch, but has so far been spared by Standard & Poor's and Moody's. MBIA hasn't been downgraded.

“I think the market is just experiencing normal profit-taking” following the Fed-charged rally, said Michael Cohn, chief investment strategist at Atlantis Asset Management, an investment-adviser firm. “After the euphoria of the rate cut, people looked down and saw the problem – financials,” he said. And they realized, “we got everything we wanted but there are still problems.”

Once the Fed's decision came down at 2:15, major indexes immediately surged out of negative territory and soon posted gains of more than 1 percent that were fueled by belief that the Fed was not done cutting rates. The decision today comes eight days after an intermeeting cut of three-quarters of a point.

"The decision probably was affected to some extent by the GDP figures released this morning, even though it's old news," said Alfred Broaddus, former president at the Richmond Federal Reserve. "The credit situation I think was really the main conditioning factor."

Federal Reserve Chairman Ben Bernanke had come under intense criticism on Wall Street for the central bank's stewardship of the economy during the downturn. But there was a feeling that a rally spurred by the aggressive rate-cutting could restore some credibility.

Financials spent much of the day in negative territory after UBS said it lost $14 billion due to mortgage-related bets in the fourth quarter. The company said in December it expected to write down about $10 billion.

But the sector turned positive after the Fed news and fueled the rally, with Bank of America and JP Morgan leading the gainers.

"The important part of this is there's been such concern about the Fed and a lack of consistency and whether the Fed is engaged in the economic issues we've got. This takes the Fed from being a headwind to being a tailwind," said David Twibell, president of Wealth Management for Denver-based Colorado Capital Bank.

Wall Street also looked favorably on the language included with the rate-cut decision, in which the Fed noted concerns about inflation and provided strong indications that more action would be taken as necessary.

"The markets now have everything they need to move higher. The real question is whether there are buyers out there at these valuations," Twibell said. "They've given everyone a reason to rethink their investment strategy in light of the fact that the Fed is going to move things forward rather than being a hindrance."

Stocks also surging after the Fed move included Boeing Airlines , which had risen earlier on strong earnings, and economic bellwether General Electric .

Yahoo, Builders Held Market Back

Yahoo! disappointed the market with a forecast that fell short of analysts' consensus estimates and was among the primary reasons that stocks spent much of the day in negative territory.

Meanwhile, the poor GDP numbers reflected how the weakness in real estate has hurt the economy, and home builder stocks gave back some of the gains the industry has seen so far this year.

UBS downgraded Centex , which reported sharply lower earnings as the company took what was seen as a kitchen-sink charge for losses related to unsold homes. Despite today's steep loss, Centex still was up more than 7 percent from the beginning of 2008, and came well off its daily lows after the Fed decision.

It was another busy day for earnings, and Silicon Laboratories was one of the big gainers after it far exceeded analyst expectations. Tupperware Brands also skyrocketed after beating the Street on earnings that jumped 38 percent, while the company also raised its outlook, and electronics manufacturer Flextronics was rewarded for beating estimates.

Merck shares were beaten down even though earnings showed that profit excluding items shot up to 80 cents a share, easily beating estimates. The stock fell on continued worries about charges the pharmaceutical suffered to settle lawsuits over its Vioxx drug and failed tests relating to cholesterol drugs Vytorin and Zetia.

In other markets, oil gained modestly while bonds eased amid earlier anxiety that the positive economic news might dampen the Fed's enthusiasm for a more aggressive rate cut.

© 2009 CNBC.com