Wall Street calm ahead of Federal Reserve 'twist' to tweak economy

On Tuesday, the stock market started to become slightly less apprehensive over the prospects for Greece receiving some kind of bail out and slightly more open to reports of a new Federal Reserve plan to tweak the economy.

Although there was no concrete news, the Greek finance minister indicated negotiations were going well for the country to get another round of financing that would stave off default. At the same time, investors also began to focus on the upcoming International Monetary Fund and World Bank meetings this weekend when finance ministers from around the world will gather.

“People are feeling a little bit better about Greece,” says Sam Stovall, chief investment strategist at Standard & Poor’s in New York.

That drove the Dow Jones Industrial Average up by more than 100 points for most of the day. However, a spate of profit taking at the end of the day resulted in the Dow gaining only 7.65 points for the day.

Also Tuesday, investors began to view more favorably the prospect that the Federal Reserve will on Wednesday announce its intentions to try to lower long term interest rates in the weeks ahead.

The idea is to do a modern version of a Fed policy from 1961 known as "Operation Twist," which involved selling short term securities and buying longer term bonds. If it drives down long term rates as hoped, mortgages could become even more affordable, banks would receive such low returns on their investments that they would begin to lend more money, and companies loaded with cash would start to put it to work with new investments.

“The primary goal of the Fed is to bring down mortgage rates, which are already at very, very low levels,” says Eric Stein, a portfolio manager at Eaton Vance, a Boston-based money manager.

Interest rates on long-term Treasury notes are already low. So many investors have fled from stocks and sought safety in 10-year US Treasury notes that those interest rates (1.95 percent) are now lower than the dividend yields on S&P 500 stocks (2.15 percent).

That dynamic has only happened once since the 1950s – in March 2009 – Stovall notes. In the previous instances, those episodes were followed by increased investment as investors swooped in to snap up cheap stocks.

“In the 12 months after those quarters where the S&P was yielding more than the 10-year note, the S&P is up 20 percent on average and it has done so eight out of 10 times,” says Stovall.

Yet on Tuesday, the Commerce Department offered a more sober report: July housing starts fell 5 percent compared with June. Housing permits rose 3.2 percent. The overall level is less than half a normal year.

Mark Lamkin, CEO Lamkin Wealth Management in Louisville, Ky., thinks the market is currently embroiled in a tug of war between the flow of positive earnings’ statements from corporate America and economic news that shows the economy at close to “stall speed.”

“The market is saying if we have any black swan event [a negative surprise] the economy could go into a recession, but the market is also saying company earnings are really good and we feel good about the prospects,” he says.

That’s one of the reasons he thinks the market is likely to stay in a limited trading range for a while.

However, Stovall says there some more optimistic “factoids.” For example, on Aug. 12 the University of Michigan/Reuters reported its consumer confidence index had tumbled to 55 – its lowest reading since 1980. One would think this is bad news. But the stock market often reacts perversely to such data, says Stovall.

“In the 12 months after any reading of the index below 60, the S&P was up an average 21 percent and the market rose eight out of 10 times,” says Stovall.