Stocks Post Big Gains on Hopes for Rate Cut

Stocks closed sharply higher as investors snapped up financial and homebuilder stocks on hopes that the Federal Reserve would keep cutting interest rates to prevent a recession.

Fed policy-makers are due to announce a rate decision on Wednesday at the end of their two-day meeting, and investors are counting on lowered borrowing costs for businesses and consumers to stimulate economic activity.

"The Fed is focused on public confidence," said Bruce McCain, head of the investment strategy team for Key Private Bank in Cleveland. A half-point cut "is what we'd expect from the Fed."

A bigger than expected drop in new-home sales for December in December fueled speculation that the central bank would continue cutting rates. Shares of home builders gained--including Lennar --on hopes that the housing market may be near its low and ready to rebound.

Financial stocks also helped bring up the indexes, led by JP Morgan, with traders betting on a half-point rate cut.

"The financials and home builders were so over-shorted, and short-covering feeds on itself," said Michael Cohn, of Atlantis Asset Management in New York. "This could go on for a couple of weeks."

But earnings reports weighed on the indexes, as McDonald's beat analyst estimates by 2 cents a share and Verizon met analyst estimates, but shares in both fell. McDonald's stock slumped due to flat December same-store sales and was the biggest loser among Dow blue-chips. Verizon was the second-biggest loser among Dow components.

But there was good earnings news elsewhere that helped keep indexes from sinking.

Glass-maker Corning reported strong profit, sending its shares up, while food distributor Sysco also gained on 7 percent earnings growth.

The numbers from Sysco and McDonald's painted a conflicting picture of a restaurant industry suffering because of the economic slowdown. The industry was the worst-performing on the S&P, falling 4 percent on losses also from Yum Brands , parent of KFC, Taco Bell and Pizza Hut.


On the downside, Alliance Data Systems shares lost more than a third of their value on news that its $6.76 billion buyout by Blackstone was in jeopardy because it may not win regulatory approval.

But economic barometer General Electric posted a strong gain, signaling further strength in the market, as did traditional Dow stalwarts American Express, American International Group and Caterpillar.

Rate-Cut Expectations Still in the Air

With the Fed deciding on interest rates Wednesday, the market is betting on another rate cut after last week's emergency cut. Fed funds futures price in about a 78 percent chance of a half-point cut.

"I expect a good market right up through the rate cut. What the market does expect, though, is a 50 basis-point cut, and if the market doesn't get that it may sell off," Cohn said. "The Fed right now is between a rock and a hard place, where they have to either appease the market or (show) they see something unusual out there that could hit the market in the future.

"They're really not in the business of appeasing traders, although everyone expects them to do that."

In other markets, oil received a lift from the gain in stocks after being down sharply earlier in the day, while bonds slipped and gold was barreling towards another record, up $16 an ounce by 2 p.m. ET.