Stocks may rally anew on Fed's acts

NEW YORK (Reuters) - Bolstered by the Federal Reserve's aggressive liquidity action, stocks could extend their solid rally next week even in the face of still weak consumer and housing-related data.

Thursday, the Dow Jones industrial average .DJI soared 261.66 points, or 2.16 percent, to end at 12,361.32, capping one of the most volatile weeks in U.S. financial market history. The Standard & Poor's 500 Index .SPX also enjoyed ample gains at the end of a holiday-shortened week, climbing 31.09 points, or 2.39 percent to end the week at 1,329.51. The Nasdaq Composite Index .IXIC jumped 48.15 points, or 2.18 percent, to close at 2,258.11.

"This will be the bottom," said Mark Zandi, chief economist and co-founder of Moody's Economy.com. "We got an incredibly aggressive Fed and three to five years from now, we will realize that this was the start of a bottoming process."

Stock investors already have been quick to sniff that out.

For the week, the Dow jumped 3.43 percent, the S&P 500 rose 3.21 percent and the tech-heavy Nasdaq Composite gained 2.06 percent.

Next week's barrage of economic indicators will include home sales, durable goods orders, consumer confidence and spending, GDP and some widely watched gauges of inflation.

But investors are likely to shake off these readings.

"There's a lot of bearishness built into expectations, so the markets could respond positively if we get any better-than-expected news from these economic reports," said Keith Wirtz, president and chief investment officer of Fifth Third Asset Management, which manages $22.5 billion.

Overall, it was the Fed's aggressive moves that have made investors increasingly confident about the stability of the markets.

"What the Fed did on multiple fronts will be an important moment in time for equity investors," Wirtz said. "The Fed was trying to blunt what could have been a snowballing effect of a lack of faith in the financial system," he said.

FINANCIALS FLY, AND SO WILL STOCKS

Sunday, the Fed brokered a deal for JPMorgan Chase & Co. (JPM.N) to take over Bear Stearns BSC.N, but it also dusted off a Depression-era rule to let securities firms borrow directly from the Fed through its discount window, usually reserved for commercial banks.

Now any bank that needs cash can go directly to the Fed window and exchange all kinds of collateral, such as mortgage bonds, for highly liquid government securities. With those Treasuries, banks then tap the $4.5 trillion repurchase market to exchange these for short-term cash loans. That money can shore up balance sheets depleted by the plunge in prices of mortgage-backed securities and other risky investments.

That's not all.

On Tuesday, the Fed cut interest rates by three-quarters of a percentage point, the sixth time it has slashed its fed funds rate target for overnight bank loans, to 2.25 percent.

Moreover, the regulator of Fannie Mae and Freddie Mac, the top providers of funding for U.S. residential mortgages, relaxed their capital rules and gave them permission to pump $200 billion more into the struggling U.S. mortgage market.

Proof that the Fed's medicine is taking effect?

Financial stocks and the broader market broke their three-week losing streak. Lehman Brothers LEH.N and JPMorgan both rose for the week by 24 percent and 26 percent, respectively. Goldman Sachs (GS.N) shares posted gains of 14.52 percent for the week.

"The market has received a lot of support and it should help thaw the frozen credit markets, which could help this market," said Alan Gayle, senior investment strategist at Trusco Capital Management in Atlanta.

SOME GOLDEN OPPORTUNITIES

Like many investors, Wirtz of Fifth Third said he is buying U.S. stocks.

"We are starting actually to buy equities this week," he said. "They've got to distressed valuations and the opportunities were too great to ignore."

Bob Doll, vice chairman and global chief investment officer of equities at BlackRock Inc, which manages more than $1.1 trillion in assets, told Reuters that he believes the bottom is in the making and added that he's been buying financial stocks "on weakness."

As for weakness in economic data, there will be pockets. But investors are closely watching on Friday, when the core PCE price index, the Federal Reserve's preferred measure of inflation, will be released as part of the report on personal income and consumption. (PCE, of course, stands for personal consumption expenditures. The core reading strips out volatile food and energy prices.)

In February, core PCE is expected to be up 0.1 percent, compared with a gain of 0.3 percent in January.

Despite the expected moderation, inflation is still edging beyond the Fed's comfort zone, tagged at 1.5 percent to 2.0 percent.

(Wall St Week Ahead runs every week. Questions or comments on this column can be e-mailed to: jennifer.ablan(at)reuters.com)

(Additional reporting by Caroline Valetkevitch and John Parry)

(Reporting by Jennifer Ablan; Editing by Jan Paschal)