Rate cut could boost consumer spending
NEW YORK - Betting on banks and movie theaters could be a good move if the Federal Reserve lowers a key interest rate at today's meeting.
Historically, companies that provide nonessential services and products and financial services firms are among the best-performing sectors in the stock market when the central bank begins easing monetary policy.
The Fed's rate-setting committee is widely expected to cut the federal funds rate from its current 5.25 percent. The rate, which is what banks charge other banks to borrow money, has been held steady since June 2006. The debate in the market is whether the cut will be a quarter-point or a half-point.
Retail, entertainment, and home-building companies would benefit because lower rates on credit cards and other loans theoretically mean consumers feel less pressure on their finances, said Brian Belski, of Merrill Lynch & Co. The prime rate, which is used to determine interest rates on many consumer loans, including credit cards, is traditionally 3 percentage points higher than the Fed funds rate.
Because consumers are likely to spend more money when rates decline and the economy improves, investors turn to such "consumer discretionary companies" in anticipation of greater earnings, said Standard & Poor's chief investment strategist Sam Stovall.
Over the last 10 periods where the Fed started cutting rates, the Standard & Poor's 500 index averaged a gain of 10 percent in the six months after the initial cut, Stovall said. Consumer discretionary stocks increased, on average, 18 percent during that same period.
Financial stocks have matched the S&P 500's average gain of 10 percent in the six months following the start of a rate-cutting cycle.
When interest rates decline, a financial services firm is able to increase the difference between how much it pays to borrow money and how much it charges to lend the money, therefore earning more, said Belski. When the margin between the rate firms pay to borrow and the rate they collect on loans is narrow, financial firms have to rely more on fees and other charges.
Flat and declining home prices and rising mortgage delinquencies in recent months could hinder the traditional boost financial firms receive, said Wayne Titche, chief investment officer at Ambs Investment Counsel. Banks are likely to continue to see mounting losses from defaulted loans in coming months, which could offset any boost the sector would receive from declining interest rates, he said.
Rate cuts don't always guarantee a rally. The Fed cut rates 13 times, from 6.5 percent to 1 percent, between January 2001 and June 2003. In the six months after the first cut, the S&P 500 fell 7.3 percent, Stovall said.
High-priced technology stocks came crashing down in 2001, overshadowing any positive impact from the rate cuts, Stovall said. But even as the overall market declined, the consumer discretionary sector rose.
