Rate Drop Seen Outweighing Slower Profits: U.S. Stocks Outlook
By Deborah Stern
New York, Jan. 27 (Bloomberg) -- Wall Street is betting that the Federal Reserve will lower interest
rates next week for the second time this month. Judging from rate cuts in past years, investors can
expect a market rally in the months ahead.
Since 1985, there have been five periods in which the Fed reduced rates several times in a row. In
four of those periods, the Standard & Poor's 500 Index began rallying within a month of the first rate
cut and three months later the index was up an average 8.6 percent.
Fed policy-makers lowered rates by a half-point on Jan. 3 in a surprise move, and the S&P surged 6
percent over the next three weeks. The central bankers meet Tuesday and Wednesday, and all 25
bond dealers that trade directly with the Fed expect another half- point cut, to 5.5 percent.
Strategists say the market will benefit from such a move.
``You can feel with some added confidence that we have indeed seen the bottom'' for the economy
and stock prices, said Brian Belski, chief fundamental market strategist at U.S. Bancorp Piper Jaffray
in Minneapolis.
Companies such as Amgen Inc. and Qualcomm Inc. rallied to help lift the Nasdaq Composite Index
0.4 percent for the week, its third consecutive weekly gain. The index hasn't put together such a
string of advances since the three weeks ending Sept. 1. The Nasdaq has climbed 13 percent in
January after losing 39 percent last year.
The S&P 500 gained 0.9 percent for the week, extending its gain in 2001 to 2.6 percent after a 10
percent decline in 2000. The Dow Jones Industrial Average rose 0.7 percent this week and is still
down 1.2 percent in 2001.
Rate-Cut Expectations
The anticipation of more rate cuts this year gives investors reason to pour money into stocks even if
profit growth won't pick up for several months, said George Mairs, who manages $1.3 billion at Mairs
& Power Inc. in St. Paul, Minnesota.
``We're in a cycle now where there probably will be further cuts in the months ahead, and the
expectation is more important than the amount of the cuts,'' Mairs said. ``People are willing to pay
more for future earnings in a lower interest-rate environment.''
Mairs recently added to his holding in regional bank Firstar Corp. Banks and financial-services firms
benefit from rate cuts because they spur demand for loans and lift the value of the bonds banks hold
in their portfolios.
The Fed's action on interest rates is helping ease the anxiety some investors had that the U.S.
economy was headed for a prolonged economic slump.
``I don't believe we're headed to a recession,'' said Bill Rutherford, who manages $100 million at
Rutherford Investment Management in Portland, Oregon. ``We're at or near the bottom.''
Stocks, particularly technology companies, are coming back this year after being beaten up in 2000,
Rutherford said.
Companies that sell equipment for voice and data networks suffered because some of their
customers -- telecommunications companies -- couldn't sell bonds to raise the money to buy new
gear. As rates fall, companies will find it easier to sell bonds, , Rutherford said.
``As interest rates come down, that pressure is going to ease,'' said Rutherford, whose largest
holdings are computer- related and telecommunications companies including Cisco Systems Inc.,
EMC Corp., Sun Microsystems Inc. and Oracle Corp.
Telecom Stocks Fall
For now, investors are still seeing the effects of that slowdown in telecom-equipment spending.
PMC-Sierra Inc. slid 30 percent this week, the biggest decline in the Nasdaq 100 Index, after the
communications-chipmaker said sales growth will slow further as demand for network equipment
cools down.
Among other network-equipment companies, Broadcom, another chipmaker, lost 16 percent, Ciena
Corp. fell 14 percent and Cisco Systems Inc. fell 4.9 percent. PMC-Sierra has tumbled 70 percent
from its March 10 high.
Not everyone on Wall Street is convinced the market is ready to come roaring back immediately.
The slowdown in profit growth may be so severe that it will overshadow the decline in interest rates,
said Charles Pradilla, SG Cowen Securities Inc.'s chief investment strategist.
``The Fed easing is clearly the beginning of the market coming back,'' he said. ``However, it's very
difficult to time. Everyone was surprised at how quickly the economy slowed'' after the Fed raised
rates in 1999 and last year.
``I don't know if it's enough to eradicate earnings worries,'' Pradilla said of the prospect of lower
rates.
Retail stocks were among the best performers this week after Goldman, Sachs & Co. analysts raised
their ratings on 10 retail and apparel stocks, citing expectations that consumer spending will pick up
in the second half of the year.
The S&P Retail Stores-Apparel surged 19 percent this week, the best showing for an industry group
in the S&P 500. Gap Inc. surged 23 percent, Limited Inc. gained 19 percent and TJX Cos. rallied
10 percent.
Analysts expect profit growth for companies in the S&P 500 to slow to 0.6 percent in the first quarter
of this year and 1.1 percent in the second quarter, down from an expected 4.4 percent in the fourth
quarter of 2000, according to analysts polled by First Call/Thomson Financial.
Analysts forecast earnings growth will pick up to 7.1 percent in the third quarter.
Companies slated to report fourth-quarter earnings next week include Aetna Inc., AT&T Corp. and
Xerox Corp. on Monday, Procter & Gamble Co., Halliburton Co. and Amazon.com Inc. on Tuesday,
AOL Time Warner Inc. on Wednesday and Verizon Communications on Thursday.
Declining Interest- S&P 500 Bottom S&P's Return Three Rate Period Months After First
Rate Cut in Series 1/3/01 - ? 1/8/01 N/A 9/29/98 - 11/17/98 10/8/98 13% 12/19/95 - 1/31/96 1/10/96
6.5% 7/13/90 - 9/4/92 10/11/90 -18% 5/17/89 - 12/20/89 5/17/89 8.5% 3/28/85 - 7/11/85 4/8/85
6.5% |
