Stocks That Ride on Rate Cuts

Author and strategist Timothy Hayes says the best plan for now is to stick to areas like retail and financial stocks

The Federal Reserve's rate cuts are helping stocks, but the market positives still have to show more breadth before producing a sustainable advance. Such is the diagnosis of Timothy Hayes, author of The Research Driven Investor and global equity strategist for Ned Davis Research.

However, Hayes's studies show that earlier cases of four rate cuts in succession came in the early stages of a recession, and it took a while before they had significant impact. For now, he suggests focusing on financial and retail stocks that will benefit as the interest-rate medicine takes effect. In financials, he particularly recommends Southeast regional banks. And he likes the specialty retailers.

Bottom line, he thinks a trading strategy will work best for investors until the market heads into a more solid advance. Hayes was a guest in a chat presented Feb. 1 by BusinessWeek Online on America Online. These comments came in response to questions from the audience and moderators Jack Dierdorff and Amey Stone. Edited excerpts from the chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: Tim, the market did pretty well today, especially considering we had bad news on the economy (purchasing managers, consumer confidence, big layoffs). Is the market responding mainly to the Fed?


Yes, the market is responding to the Fed's second rate cut. When the Fed cuts rates two times in succession, the market tends to move higher after that.

Q: So are you basically bullish at this stage? What is your outlook for the rest of 2001?

A: Well, it should be noted that of all the cases where we've seen four rate cuts in succession, it has been in the early stages of a recession. Those periods were 1929, 1957, 1960, and 1981. The response to all these cuts was subdued or delayed.... Overall, it'll be a volatile year, and a lot will depend upon whether the market begins to believe that the Fed is sufficiently going to be able to turn around the economy.

Q: Can you explain the concept behind the title of your book The Research Driven Investor?


Sure. The point of the book is that to be able to stay on top of where the market is going, it's important to have the proper...understanding of what drives the market and how you can best gauge the market risk...and how you can position yourself to be in the right types of stocks in the right environment, based on what history has shown us.

Q: What measures should investors be particularly looking for in this market?


I think that one of the things we needed to look for was the second rate cut, which we've had.... I spent an entire chapter talking about why we shouldn't fight the Fed. The second part is another expression, "Don't fight the tape." A large part of the book talks about the action of the market itself and how the breadth of the market can give you clues to momentum and broad participation. A breadth thrust, as it is called, occurs early in prolonged advances. We've had some good breadth numbers recently, but we need some higher numbers to have a sustainable advance.

Q: What are your favorite sectors for 2001?

A: I think to answer that question we should start with what kind of monetary environment we are in, which is one of easing, and we should also look at the fact that the market is trying to climb out of a negative period right now. For starters, we should consider that financials, the bank-loan sector, will do well and should continue to do so as long as we don't have a credit crunch, and as long as the dollar does not decelerate rapidly.... If the Fed's easing does have an impact, turning the economy in a positive direction, retail should be a sector that does well in 2001, as well. Technology right now still has some valuation problems, I believe.

Q: You mentioned retail -- what are your thoughts on Wal-Mart (WMT ) and Home Depot (HD )? Near and five years out?

A: Well, when it comes to individual stocks, let me first explain our optimal stock-selection criteria. We take a top-down approach, looking first at the economy, the health of the market, and so on. Then we look at sectors, and then, finally, individual stocks.... Right now in retail, our specialty-retail group has performed well on a relative basis. We don't at this point see Wal-Mart or Home Depot on the top of our list.

Q: So what retailers do make your list?


We have the following stocks that have shown up here in the last week: Rent-A-Center (RCII ), American Eagle Outfitters (AEOS ), Toys 'R' Us (TOY ), Starbucks (SBUX ), Pier 1 Imports (PIR ), Venator Group (Z ), O'Reilly Automotive (ORLY ), and Bed, Bath & Beyond (BBBY ). Also, in the retail-drugstore group, we have CVS and Walgreen's (WAG ) on the list. They aren't new to the list.

Q: Can you name some financial stocks you think will do well this year?


Some regional banks on the list include Richmond County Financial (RCBK ), Synovus Financial (SNV ), SouthTrust (SOTR ), Mercantile Bankshares (MRBX ), First Tennessee National (FTN ), First Citizen Bancshares (FCNCA ), Popular Inc. (BPOP ), National Commerce Bancorp (NCBC ), First Virginia Banks (FVB ), and BB&T Corp. (BBT ). These are just stocks from our Bank Southeast Group, which ranks third among 100 groups in our rankings. Of the financial group, this is the highest-ranked right now.

Q: Tim, you mentioned that you think technology stocks still have valuation problems. Do you think the Nasdaq will fall again this year? And are there technology stocks that you recommend now, despite the high prices?


Well, we've had a good move already in technology, and yes, if you look at the price-earnings ratio for the Nasdaq, it's still high. It has corrected somewhat, but we still don't have a long-term move in front of us. I think that's why our focus list doesn't pick up a lot of tech stocks now. Currently, we have three tech stocks on our list, out of approximately 130 stocks.... These three are from the office-supplies group, so they are not really pure tech-oriented. They are Steelcase (SCS ), Diebold (DBD ), and Wallace Computer Services (WCS ).

Q: What kind of performance track record has your list had? Especially over the last troubled year?

A: We have outperformed the equal-weighted S&P 500, which is the S&P 500 not capitalization-weighted.

Q: Do you find that the average investor takes readily to learning how to do research, or is it an uphill sell?


Interesting question. I think more people are realizing they can't count on blindly following the advice of brokers. They really need to understand what the market is all about and what's driving it and why it's doing what it's doing.... Plus, people now have so many more analytical tools, indicators, and models at their fingertips.... With the advent of Internet trading, people have had a greater desire to learn these tools.

Q: Tim, are there any Web sites that you recommend for investors who are researching a new stock or trying to figure out the market direction?


Actually, in the book I have a chapter devoted to Web sites, and it breaks down what Web sites are most suitable for what you want. I break them down into market-info sites, sites for economic and monetary data, trading services, charting, education, sites that have good links to other sites, and also sites that have trading software that is downloadable.

Q: Considering the state of consumer confidence, I'm a bit surprised to hear you and other analysts recommend retailing. Is this a strong bet on lower interest rates really working?


Yes, it is.... The market is forward-looking, and it's often when the situation looks really bad that the opportunity is the greatest. That's why we see retail as an opportunity right now.

Q: Tim, I notice that you have the word "global" in your job title. Are there any foreign markets that you recommend currently? Do you think investors should maintain part of their portfolios in international companies?


Yes, I do, especially now that the dollar is in a downtrend. This represents an opportunity for investors to benefit by global diversification. We could now see some relative strength overseas. We've been focusing on the relative strength of Latin America, specifically. A lot of the bad news, the dire economic news, had been factored in in that region. Now it is looking much better.... And two of our top markets are Venezuela and Brazil. In fact, those are the two top markets in our ranking. The other Europe, which is looking more promising. The euro should now attract funds into Europe. The economic situation is better. They've gotten through high oil prices very well.

Q: Tim, do you think investors can use a buy-and-hold strategy in the current market? Or is it smarter to trade in and out of the market -- especially since it sounds like you expect some more weakness in the spring or summer?


I think that having a trading strategy this year would be a good idea because of the chance that we will have continued high volatility in this uncertain environment, where we could see another sell-off at some point. So ideally, you would want to be able to lighten up if and when that happens, because we don't have a green light yet that we're at the start of a sustainable long-term advance.

Edited by Jack Dierdorff

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