By Sam Stovall The Federal Reserve did the unexpected last week by cutting short-term interest rates by 50 basis points, four weeks ahead of the May 15 meeting of its policy-making arm, the Federal Open Market Committee (FOMC). Many investors instantly wondered what the Fed saw in prior reports, or was likely to see in future reports, to cause them to take this pre-emptive action.
Let's see... Last week, the Philadelphia Fed Index for April showed a 7.2% decline, following a 23.5% slump for in March. That couldn't have been it. That was old news. So was the Industrial Production report, which actually posted a surprise increase of 0.4%. Nor was the CPI report anything to get concerned about, since it came in as expected by posting a 0.1% advance.
Was it something lurking in this week's reports? Well, Consumer Confidence is likely to slip to 115 from 117. I wouldn't lose sleep over that, nor would I be concerned over the projected 1.5% increase in Durable Goods Orders. In addition, New Home Sales and Existing Home Sales are likely to show a modest increase and decrease, respectively, while Q1 2001 GDP appears to have risen 0.8%. I would neither call that the makings of a recession, or the reason for an inter-meeting rate cut.
Maybe, like our parents, the Fed doesn't always need a reason to do things, especially when they are looking out for our own best interest. But I can tell you that it is not the first time that the Fed has acted this aggressively. A reporter called me last week saying "This is the first time in history that the Fed has done this!" Of course I was suspicious, so I went to the Fed's own web site (www.ny.frb.org/pihome/statistics/dlyrates/fedrate.html) and found that on four separate occasions, the Fed has cut rates four times in a row.
From a stock market standpoint, investors LOVE rate cuts. In the six and 12 months after each of these aggressive moves, the S&P 500 advanced an average of 17% and 26%, respectively, while the Nasdaq posted a 23% return six months after the fourth cut and an average 38% advance 12 months after.
What about sector returns, you ask? Which of the sectors in the S&P 500 do you think posted the strongest advance in the period following four successive rate cuts? I'll give you a couple of seconds to come up with your answer. (Insert "Jeopardy" theme song here.) Time's up. The answer is: What are Consumer Cyclicals?
Avg. % changes of underlying industries in existence since 1971.
The average advance for the 12 industries currently in the Consumer Cyclicals sector that date back to 1971 was 29% during the six months after the fourth cut in interest rates, followed by gains of 19% to 21% for the Health Care, Financials, and Transportation sectors. The weakest performances came from Energy, Utilities and Technology stocks, which rose an average of 8% to 18%. It is interesting to note that none of the 56 industries that participated in this study posted average returns that were negative. It seems a rising tide really did lift all boats.
As a result of this recent move by the Fed, and the projected effect it will have on our economy, S&P analysts recently upgraded several economically sensitive issues to 5-STAR status. First was Smurfit-Stone Container (SSCC), going to 5-STARS from 3-STARS on the improving outlook for the economy. IndyMac Bancorp (NDE) was again made a 5-STAR stock due to favorable fundamentals and a recent price drop. IBM Corp. (IBM) is now a 5-STAR company, since it is exhibiting strong EPS momentum, and KLA-Tencor (KLAC) was cherry-picked into the 5 STAR ranks since Tom Smith, S&P's Semiconductor Analyst, sees the company benefiting from the upturn projected for the economy and the industry.
These companies join the more than 80 companies in S&P's 5-STAR list, along with the five stocks that are in the Consumer Cyclicals sector: BJ's Wholesale (BJ), Cendant Corp. (CD), Clayton Homes (CMH), Home Depot (HD), and Scholastic Corp. (SCHL). Stovall is Senior Sector Strategist for Standard & Poor's