BUSINESSWEEK ONLINE : JANUARY 15, 2001 ISSUE
NEWS: ANALYSIS & COMMENTARY Will It Do the Trick? History Sides with the Bulls Don't fight the Fed. That age-old Wall Street axiom means that if the Federal Reserve is cutting interest rates, bet that the market will go up. Or if it's raising rates, put your money on stocks going south. And with the Fed's surprise 50-basis point interest-rate cut on Jan. 3, accompanied by a rip-roaring rally in the market, sending the Nasdaq and Dow soaring 325 and 300 points, respectively, the axiom certainly seems to have been underscored. In moving so quickly, ''the Fed was reacting to the market's mounting losses,'' says James A. Bianco, president of Bianco Research LLC, a bond market research firm. But many people are wondering if the rally will hold--or if, despite rate cuts, the stock market, along with the rest of the economy, will resume its slide once the euphoria over this initial cut has subsided. More often than not, history has been on the side of the bulls. In 7 out of the 10 rate easings from 1973 to 1995 during a period of economic weakness or slowing, the market has responded positively, according to a study by Goldman, Sachs & Co. In fact, Edward F. McKelvey, a senior economist at Goldman, compares the current environment with July, 1995, when the Fed decreased rates by 25 basis points to preserve an economic expansion. Three months after the cut, the Standard & Poor's 500-stock index had risen some 25% over where it was six months prior to the cut. And, according to Brown Brothers Harriman & Co., when rate easings occur in the year after a down year for the stock market, stocks tend to stage a robust recovery. So even if market jitters don't entirely disappear overnight, it's likely that interest rate cuts will eventually give the market a sustained boost. The rate cuts, coupled with a likely tax cut this year, will certainly make for a potent stimulus package, say strategists. ''We have an additional 50 basis points priced in over the next quarter. And with a tax cut coming, you don't want to own bonds. You want stocks,'' says Bianco. But before you load up on all those stocks you were terrified to buy last year, heed some important caveats. For one, the stock market has not always staged a sustained recovery after an initial Fed move. And that may be especially true this time, according to Bruce Steinberg, chief economist at Merrill Lynch & Co., because the economy is continuing to slow. Now, the projected consensus for growth of real gross domestic product in 2001 is 3.1%, vs. 4% in 2000. ''One cut won't do it, and by acting now, they have the FOMC meeting on Jan. 31 where they can ease more,'' says Steinberg. BIG WINNERS. You can forget about a Lazarus-like revival for the Nasdaq and technology stocks, too, despite the Jan. 3 rally. ''The Nasdaq will still lag behind the rest of the market, at least for the first half of year,'' says Charles H. Blood, chief investment strategist at Brown Brothers Harriman. Tech earnings will continue to come in slow. They're expected to grow 11% in 2001, vs. 27.6% last year, according to earnings researcher First Call Corp. And though technology has been shown to be more economically sensitive than previously thought over the past year, many experts say it still does not correlate as closely with Federal Reserve policy as other sectors of the market do. ''It didn't bother the technology sector when the Fed was tightening, and it won't matter when the Fed is easing. Semiconductors could be the only exception,'' says Bianco. The sectors that will benefit most from a rate-easing environment: financials, faster-growing retailers, and health-care companies. ''These are more defensive growth sectors, where growth may not be as rapid as tech but is much more consistent,'' says Brown Brothers' Blood. For that reason, it's likely that the S&P 500 and even the Dow Jones industrial average could continue their ascent. According to the Goldman study, in cases where the Fed used rate cuts to successfully prolong an expansion, much like the current environment, the market generally improved even before the first rate cut. Three months after the onset of rate easings, the S&P 500 was up nearly 5% on average, and by six months, it had gained a total of 8.5%. This time, the market did not improve in anticipation of rate cuts. And ''if easing doesn't cause a sustained recovery soon, stock market declines could be massive over the next year,'' says Goldman's McKelvey, who sees only about a 35% chance of that. In 1981, for instance, stock prices declined 10% in the three months after the Fed cut interest rates. The reason: The economy had already reached the brink of recession, and investors viewed the rate easing more as a postponement of a recession than an avoidance of one, says McKelvey. For now, most economists and strategists agree that it looks as if the Fed's easing will head off a recession this time around. If that's the case, it's likely the bears will be wrestled to the ground. By Marcia Vickers in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Kindest Cut of All TABLE: Dr. Greenspan's Elixir Will It Do the Trick? History Sides with the Bulls CHART: Celebrating the Cut CHART: Rate Cut Rallies INTERACT E-Mail to Business Week Online

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