-- The Federal Reserve's attempt to calm credit markets may have the opposite effect on equities after the most volatile week for U.S. stocks in four years.
The Chicago Board Options Exchange Volatility Index stayed near the highest since 2003 after the Fed unexpectedly reduced the rate it charges banks for loans on Aug. 17 and sparked the biggest rally in the Standard & Poor's 500 Index in four years.
``When you go from just fear to fear and greed, you almost introduce more volatility,'' said Jim Paulsen, who helps oversee about $175 billion as chief investment strategist at Wells Capital Management in Minneapolis. ``You don't just go from where we've gone and instantly come back to stability.''
The S&P 500 gained at least 7 percent in a week after the volatility index, or VIX, reached its highest readings in the past decade. Increasing price swings create opportunities for speculators and investors who seek stocks that have risen or fallen too much compared with earnings.
Goldman Sachs Group Inc., whose hedge funds lost $3 billion in August after the S&P 500 declined 6.9 percent from a July 19 record, said in a letter to investors last week that a ``significant investment opportunity'' now exists.
The VIX, which gauges investor expectations for future share-price swings, rose to the highest in the past 10 years during the 1998 Russian debt crisis, the September 2001 terrorist attacks and WorldCom Inc.'s July 2002 bankruptcy.
Worse Losses
The Fed's 0.5 percentage point reduction to its discount rate suggests losses from subprime mortgage defaults are worse than previously known, said Jim Melcher, president of Balestra Capital Ltd. in New York.
``There's reason to believe there will be a lot more volatility,'' said Melcher, whose hedge fund has climbed more than 85 percent this year. ``Why would they do this if things were just fine?''
Asian shares rebounded today from their worst week in 17 years, following gains in the U.S. and Europe triggered by the Fed's move. The S&P 500 index rose 2.5 percent and Europe's Dow Jones Stoxx 600 Index added 2.1 percent on Aug. 17, the first gain in four days.
The Morgan Stanley Capital International Asia-Pacific Index added 4 percent to 142.61 at 9:24 p.m. in Tokyo, its biggest gain since May 2004. A measure of the index's volatility rose to its highest in more than a year.
Macquarie Bank Ltd. jumped the most in almost a decade and Canon Inc. had its biggest advance in five years. Toyota Motor Corp. and Samsung Electronics Co. climbed on reduced concern the U.S. economy, the world's largest, will slow.
Bigger Risks
``The rate cut was pretty effective in curtailing panic in the markets which have no direct link to the subprime loan problem,'' said Masayuki Kubota, who helps oversee $2.1 billion in assets at Daiwa SB Investments Ltd. in Tokyo. ``Global growth won't be hampered by the subprime issue.''
The Fed said it reduced the discount rate to 5.75 percent because risks to economic growth have risen ``appreciably.'' The statement was a departure from the previous week, when central bankers kept rates unchanged a ninth straight time and reiterated inflation was their ``predominant'' concern.
``What the Fed did provides a psychological safety net,'' said Russ Koesterich, who helps manage about $1.9 trillion at Barclays Global Investors in San Francisco. ``The bearish argument is that it may not be enough, or it's too little, too late.''
Losses in bonds tied to home loans made to the riskiest borrowers had led to a rout in global stock markets that wiped out $4.78 trillion in value.
Less Predictable
The volatility index averaged 23.6 in the month since U.S. stocks rose to records, 85 percent above the average in the previous year. Its average close was 29.15 last week, the highest since March 2003.
The Fed's actions have been less predictable for investors since Chairman Ben S. Bernanke took over in February 2006 after more than 18 years under Alan Greenspan's leadership, said Doug Peta, strategist at J&W Seligman & Co. in New York, which oversees about $20 billion.
Options on Fed funds futures show traders see a 64 percent chance that policy makers will cut their benchmark rate by 50 basis points to 4.75 percent at the next meeting on Sept. 18. The odds for a cut to 4.5 percent at the Oct. 31 meeting rose to 56 percent. There was zero probability for both outcomes a week ago.
``The market had gotten very comfortable with the way the Alan Greenspan Fed operated,'' he said. ``Now, there is a new sheriff in town. Subprime mortgages, the ripple effects in other markets -- we don't know where that ends, or have a great idea of how to quantify it. Therefore, we are primed to see moves like we've been seeing.''
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