Rate Cut Jump-Starts Market’s New Year

Now where does one invest?

After the Federal Reserve’s dramatic interest rate cut Wednesday, everyone from highly paid money managers on Wall Street to day traders on Main Street were scouring the markets for the best plays in an environment of declining rates.

The pros’ picks? Many like several areas of the beleaguered technology sector, which made investors miserable in 2000. Their choices include providers of telecommunications gear such as JDS Uniphase, and business-to-business Internet exchanges such as Ariba.

The appeal of biotechnology stocks, such as Amgen, also is burnished. And some managers favor shares of specialty retailers, such as Target, and so-called cyclical and capital-goods stocks that include steel and aluminum producers.

Investors seemed to agree Wednesday: Many of those sectors rallied sharply, as did several other industries that usually react to interest rate changes, such as home-building stocks and real estate investment trusts.

As the Fed cuts rates, general borrowing costs should fall, which could raise demand for real estate and home building. Lower rates also help companies that typically operate with debt-laden balance sheets--such as airlines and biotechnology firms--because their interest payments will decline.

Meanwhile, “defensive” stocks--which investors had embraced amid the drubbing in the technology and other high-growth sectors--were among the day’s big losers, as investors promptly dumped them and jumped back into the tech market.

The casualties included supermarket chains such as Kroger, drug makers including Merck and energy stocks such as Chevron. But analysts warned that, even if Wednesday’s rally blossoms into an enduring, broad-market rally, many of those defensive stocks will still be popular because they’re still not overly priced and the rate cuts will bolster their profit margins, too.

Yet one of the sectors most sensitive to rate changes--financial-services providers--drew a mixed response. Bank and brokerage shares rose, but many insurance and savings-and-loan issues fell.

Financial stocks typically should do well as rates decline, because the trend lowers their main operating cost--what they pay for the cash they lend or manage--and that boosts profits. Problem is, expectations already had grown that rates would come down sometime this year, so the stocks already had rallied nicely.

Now, even though the Fed’s half-point cut was unusually large, “I would be leery of some of the financial stocks,” said Brian Belski, a market strategist at US Bancorp Piper Jaffray in Minneapolis, because many “have been outperforming the market for the past six months” and their momentum could fade.

That said, brokerage stocks could be winners if the market sustains Wednesday’s rally, generating more business for Wall Street firms. Investors are already acting on that belief, snapping up shares of Lehman Bros., Charles Schwab and online brokerage E-Trade Group.

The outlook for lower rates especially bolsters computer, computer-equipment, long-distance telephone, software and semiconductor stocks, analysts said, and all of those sectors ranked among Wednesday’s biggest percentage gainers, with double-digit advances.

Spending on tech gear slowed late last year along with the U.S. economy. But with interest rates coming down, prospects for renewed spending on everything from personal computers to Internet-networking systems could pick up again this year, analysts said.

Telecom-equipment makers offered a good example of why the Fed’s action sent their stocks soaring. Many buyers of that equipment, notably struggling long-distance carriers, “have a pretty substantial debt load” and the rate cuts gives them more breathing room to order new equipment, said Kevin Slocum, an analyst with SoundView Technology Group.

“So lower rates are clearly something that can be beneficial to a Corning, a Lucent Technologies, a Ciena,” Slocum said. “I can’t tell you that a half-point cut ends up being enough” to power them to a sustained rally, but it’s a help.

The same reasoning applies to biotechnology firms, many of which carry lots of debt because of their heavy research-and-development spending, said Belski, who’s now recommending such biotech stocks as MedImmune and Biogen.

As for retail stocks, it’s too early to say how much consumer confidence--and spending--will improve after last year’s lackluster holiday season and several retailers’ disappointing earnings reports.

Still, prices of many retail stocks have drooped to five- and even 10-year lows, so the stocks are compelling as interest rates fall, Belski said. He especially likes Best Buy and Gap. Those two, plus stocks such of home-improvement chains as Home Depot and Lowe’s, all surged Wednesday.

Meanwhile, bonds aren’t to be ignored just because stocks are rebounding or because bond prices are coming off a 2000 rally, credit analysts said. Prices of long-term Treasuries fell after the Fed’s action Wednesday, but that was mostly attributed to profit-taking.

“The bottom line is that the Fed is cutting rates, it’s going to cut rates again and inflation is not a negative thing right now,” said Mario DeRose, fixed-income strategist at Edward Jones & Co. in St. Louis. “That’s positive for bonds, and we expect bond rates to go down as the year goes on,” which in turn will send bond prices higher, he said.

Overall, though, investors must stay cautious about the Fed’s action because, although seemingly bullish, it might also reflect that “the Fed is concerned the economy is entering a recession,” said Bruce Kasman, head of U.S. economic research at J.P. Morgan Chase.

“If we’re actually in the early stages of a recession . . . what you’re seeing in the market today is a bounce which will not be followed by a tremendous rally,” Kasman said. “Not that the equity market can’t do better, but it does limit the upside.”

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Fed Victims: “Defensive” Stocks

Here are the industry sectors in the Standard & Poor’s 500 index that fell most sharply Wednesday. Most are so-called defensive sectors, meaning investors view them as safer havens when recession threatens.Wednesday dropStock sectorSource: Bloomberg News Los Angeles Times