Financial worries subside, small caps rally

Small-cap stocks staged a solid recovery rally Tuesday, climbing more than 4% off the morning low as investors turned off the panic switch on financial worries, while bargain hunters took a dive back into the market and short-sellers took profits. While that might not be the optimal scenario for stock market stability, it was still a welcome sign for a market that seemed to be teetering on the edge. For the day, the Russell 2000 (NYSE:IWM) was up 20.89, or 3.03%, at 710.65. Just one day after the worst performance of the year, the Russell mounted the best one-day gain since July 16, which underscores the manic volatility in play in equities right now.

After posting the largest one-day slide since the 9/11 attacks, the Dow pushed higher Tuesday, rising 1.30% and the S&P 500 was up 1.75%. For the year, the Dow is down 16.6%, the S&P 500 off 17.3% and the Russell down 7.2%.

The Federal Reserve decided not to cut short-term interest rates, even though the market gave the policy makers a green light to do so, pricing in overwhelming odds for a rate cut (via Fed funds futures) ahead of today’s FOMC policy meeting. Even though some might have been disappointed that the Fed didn’t come charging to the rescue with easier money, the market overall seemed satisfied that the policy body was ready to keep bullets in the holster for later should they be needed.

“The FOMC’s decision reflected their belief that it is not the cost of credit that is causing the current financial turmoil, but the availability of credit and liquidity,” Steven Wood, chief economist with Insight Economics, said in an email. “The Fed is trying to address this availability problem through the variety of liquidity facilities that they have put in place over the past 10 months. The Committee is clearly keeping a watchful eye on both the current financial turmoil and the increased downside risks to economic growth. Although inflation remains uncomfortably high, it has moved to the back burner given the immediacy of the financial and growth concerns. With inflation beginning to ease, and the economy in some difficulty, the Fed is now more likely to cut rates than raise them. We expect at least one rate reduction before . . .

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