Who wins from a rate cut?

January 31, 2001: 2:39 p.m. ET

Which sectors stand to benefit the most from the Fed move
By Staff Writer Alex Frew McMillan

NEW YORK (CNNfn) - With the stock market, a Federal Reserve rate cut raises all boats. Reducing the cost of borrowing pumps new blood into companies' expansion plans. It promises better profits. Lower interest rates make stocks a more-attractive investment option over cash or bonds.

Wednesday's rate cut was drastically needed, according to many market watchers. Equity strategists predict more, aggressive cuts this year. Many see the Fed reducing interest rates another three-quarters of a percentage point to a full percentage point through June.

But rate cuts take around nine months to filter through. U.S. companies may be in for a tough time the next two quarters, with more earnings disappointments. Market watchers expect more layoffs like those from Chrysler, which is shedding 26,000 workers.

"The problem is they [the Federal Reserve Board] are still behind the curve," said Jim Glickenhaus, portfolio manager at Glickenhaus & Co. "It's not as if these things are instantaneous, cut rates and tomorrow morning the economy straightens out."

The winner stocks
Meantime, what market sectors benefit the most from lower rates?

Some of the biggest winners are financials, according to many strategists, who expect the sector's solid performance over the past year to hold up.

"They're the big beneficiary of this kind of move," said Rod Smyth, chief investment strategist with First Union Securities.

Click here to check out financial-stock performance today.

Better margins, more business
Banks borrow short and loan the money long, so a reduction in rates helps them immediately. When interest rates drop, banks have more room to maneuver with their spread – the difference between the cost of borrowing money and the rate at which they lend.

There is also a lag between the Fed lowering rates and banks reducing credit-card interest and the like. All those factors help banks become more profitable.

A rebounding economy would also benefit banks. Consumers would buy more cars and houses. Companies would borrow more money.

Jay Pelosky, global strategist with Morgan Stanley Dean Witter, noted that Wall Street is worried banks' loan portfolios are deteriorating. As the economy improves, banks have less risk that their borrowers won't pay them back. That helps big banks, with a lot of corporate debt.

Smyth at First Union also likes financials. But he prefers regional banks to big financial-services firms. Regional banks are almost pure plays on lending, he noted, and he likes their lower exposure to corporate bonds and the capital markets.

Insurance companies top performers
Government-sponsored agencies like Fannie Mae (FNM: Research, Estimates) and Freddie Mac (FRE: Research, Estimates) also stand to gain from an interest-rate cut. In the long run, the companies, which package mortgages, stand to gain business when home buying rebounds.

Short-term, government agencies have big bond portfolios. When interest rates drop, so do bond yields. Bond values go up, meaning the agencies' portfolios become more valuable. The same applies to insurance companies, the biggest holders of corporate bonds, which get a boost from a rate cut.

According to a report from J.P. Morgan Chase & Co., the industry groups that have performed best when three-month Treasury bill rates have been dropping – as they do prior to rate cuts -- are life insurers; retailers; government agencies; restaurants and household-products makers.

Why are retail and restaurants near the top of the list? Greenspan's plan in lowering rates is to spur consumer and corporate spending. Those industries gain when consumers open their purses more generously.

A report released Wednesday from Bear Stearns identifies retail stocks like Bed Bath & Beyond (BBBY: Research, Estimates), Federated Department Stores (FD: Research, Estimates), Gap (GPS: Research, Estimates), Home Depot (HD: Research, Estimates) and Wal-Mart (WMT: Research, Estimates) as winners when the Fed cuts rates.

"When monetary policy turns more accommodative, the more cyclical, leveraged and more-volatile asset classes generally outdistance defensive names," explained Elizabeth Mackay, Bear Stearns chief investment strategist, in a release on the report. She expects results six to 12 months after the Fed started easing.

Besides retailers, transportation companies and automobile makers also stand to benefit over the long run, if Greenspan's efforts work. They sell products that consumers might skip when credit is tight.

Real-estate stocks should get a boost, too, as homebuyers find locking in a mortgage more attractive. Home-construction companies and furniture companies may see a follow-through effect.

A lower debt burden for telecoms
Lower interest rates help companies that have to borrow to expand, or have borrowed to expand. Industrial stocks that depend on corporate spending for big-ticket items rise.

One sector many analysts agree will gain from lower rates is telecommunications. Telecom companies have had to borrow heavily to build out their wireless infrastructure. They need to make further expansions to their networks. So they carry a heavy debt burden.

They were also one of the worst-performing sectors last year. "We think telecoms have been severely beaten down, are deeply oversold, and represent interesting value opportunities," Pelosky said.

Some strategists believe an easing Fed stance is good news for technology companies. Glickenhaus thinks increased telecom spending will benefit techs like Texas Instruments (TXI: Research, Estimates), Micron Technology (MU: Research, Estimates) and Altera (ALTR: Research, Estimates).

Click here to see how telecom stocks are doing today.

The Bear Stearns report highlights stocks like Applied Materials (AMAT: Research, Estimates), EMC (EMC: Research, Estimates) and Oracle (ORCL: Research, Estimates) as being among winners from a rate cut.

Divided on techs
But other analysts aren't as bullish on tech. Smyth thinks stocks like Cisco Systems (CSCO: Research, Estimates), JDS Uniphase (JDSU: Research, Estimates) and Sun Microsystems (SUNM: Research, Estimates) are still very vulnerable to earnings disappointments, even though they've come down from their highs.

The economic slowdown that has prompted the Fed to cut rates is bad news for technology spending by businesses. That, in turn, means less demand for the latest high-tech equipment and slower business for companies that make it.

That is why many strategists recommend keeping a conservative tack. They warn that the reason the Fed is acting aggressively in reducing rates is that the U.S. economy has derailed.

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