The Stock Market: Zap!

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Is that time at hand? A lot of people think so. "The broad economy is not as bad as the technology economy. More people are starting to wake up to the fact that this is a technology problem," says Thomas McManus, portfolio strategist at Banc of America Securities in New York City. Certainly there are hopeful signs. Consumer-sentiment figures released by the University of Michigan Friday suggest that the pessimism may be leveling off. Car and home sales have held up reasonably well, drawing down inventories, a critical issue. Consumers have been refinancing their homes at the fastest clip in several years. Energy prices have stabilized. Despite a rash of announced layoffs, the unemployment rate remains low at 4.2%. And cash is piling up. Mountains of the stuff are accumulating in money funds--a record $2 trillion--presumably waiting to come back into stocks at the first sign of a revival.

Most important: given time, falling interest rates almost always work, and with inflation low the Fed has room to cut away. Why isn't the stock market responding now? "In the early innings of a weak economy there's always a battle between lower interest rates and falling corporate profits, and falling corporate profits always win," says Richard Bernstein, strategist at Merrill Lynch. In that respect, he says, there's nothing unusual about what's happening. Investors are focused on the bad news. Eventually, though, falling rates breathe life into an ailing economy--and into the stock market well in advance.

Since 1921, in 13 cases in which rates were cut swiftly three times in a row, the Dow has been higher one year after the third cut on 12 occasions. A cut this week would be the third this go-round. The median gain in the 13 cases was 25%, according to Ned Davis Research. The NASDAQ, which came into being in 1971, has never been negative a year after a third consecutive rate cut, and its gains have also been impressive.

Stats like that give bullish analysts plenty to talk about. "The economy will be picking up significantly by the fourth quarter," says Bruce Steinberg, chief economist at Merrill Lynch. "Corporate earnings should be picking up at the same time, and the stock market, because it looks to the future, is going to be going up well in advance of that. I really think sometime in the spring the market will turn around."

As for comparing the U.S. economy with the downwardly spiraling Japanese economy, analysts note a host of differences. The main one: the Japan bubble was built on rising real estate values. Banks were heavily exposed through mortgages and commercial-property loans. The U.S. bubble was in a narrow sector of stocks. Some banks are exposed through private equity investments; but for the most part, even if your portfolio tanked, your bank doesn't have much at risk. Healthy banks are vital to a healthy economy.