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PROOF THAT THE MARKET DOES LOVE A RATE CUTHistory shows that stocks in many industries quickly respond in a positive wayThe market loves lower interest rates, or so investors have been told for years. But should they really take stock in this old adage? At Standard & Poor's we decided to put it to the test -- and identify which industries are most affected when the Federal Reserve lowers interest rates (see "Table: The 10 Best and 10 Worst Industry Performers"). To get answers, we computed the six-month performance of the market and individual industries after the Fed's first discount rate cut following a period of rising or flat rates (if the Fed cut rates multiple times in a row, we considered only the first one). We used the discount rate because the Fed historically has made this public -- the markets have had to guess about changes to the federal funds rate until just a few years ago. Since 1960, there have been 11 such first-time discount rate cuts. In the six-month period after this change in interest rate direction, the S&P 500 rose an average of 12.3% and did so 73% of the time (after 8 of the 11 cuts). That's nearly a 25% annualized rate of return, more than double the average full-year return since 1960 of about 10%. So the adage is true: The market is indeed bullish -- very bullish -- on falling interest rates. SECTOR SURVEY. Part two of our query -- which sectors thrive and which suffer in a declining-rate environment -- was also clear: Consumer cyclicals perform best while basic materials stocks lag behind the pack. Five of the 10 best-performing industries came from the consumer cyclicals sector: hotels, shoes, retailing, apparel manufacturers, and newspapers. This is not surprising, since an easing in interest rates usually causes consumers to go out and spend a little on themselves without going overboard (which also explains why building materials and autos -- two bigger-ticket consumer cyclical industries -- showed up among the underperformers). Consumer staples and technology had two members each in the top 10, while transportation had one. Among the worst performers, the majority came from the basic materials sector. This too is understandable, since a lowering of rates implies that the Fed is no longer concerned about inflation. Therefore the metals industries that usually do well in an inflationary environment -- aluminum, copper, gold, and iron/steel -- will likely be underperformers. It's important to note that even the worst performers posted results that weren't too shabby. None showed negative returns on average, and the lowest return works out to an annualized increase of about 6%. So in this case, "worst" doesn't mean you lost money -- just lost an opportunity for better gains elsewhere. Of course, this is a study of historical price performances under varying economic conditions, none of which is identical to what exists now. So while it's clear that declining rates have been very good to the market in recent years, there's no guarantee that will be the case going forward. If that sounds like another old adage, you're right.
By Sam Stovall, chief sector strategist, Standard & Poor's RELATED ITEMS
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Updated Oct. 29, 1998 by bwwebmaster
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