What sectors benefit from a rate cut?

What sectors benefit from a rate cut?

NEW YORK - Betting on banks and movies theaters could be a good move if the Federal Reserve lowers a key interest rate at Tuesday's meeting.
Historically, consumer discretionary, or 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.

The consumer discretionary sector, which includes retail, entertainment and homebuilding companies, benefits because lower rates on credit cards and other loans theoretically means consumers feel less pressure on their finances, said Brian Belski, chief U.S. sector strategist at 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 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 has averaged a gain of 10 percent in the six months after the initial cut, according to Stovall. Consumer discretionary stocks have increased, on average, 18 percent during that same period, he said.
"In general, consumers like to spend money," said Wayne Titche, chief investment officer at Grand Rapids, Mich.-based Ambs Investment Counsel, which manages $650 million in assets.
Titche added that this time around consumers are more likely to spend on smaller-ticket items like personal electronic devices if rates are cut because of the size of the investment and other current market factors.
Companies like computer hardware maker Seagate Technology and freight services provider FedEx Corp. are poised to benefit from a rate cut, Titche said. With consumers purchasing more electronics like computers and companies needing to ship additional products to meet consumer demand, both companies should benefit from lower interest rates, he said.
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 on that channel of business, said Merrill Lynch's Belski. When the margin between the rate firms pay to borrow and the rate they collect on loans is narrow, such as in the current market, financial firms have to rely more on fees and other charges to turn a profit.
Flat and declining home prices and rising mortgage delinquencies in recent months could hinder the traditional boost financial firms receive, Titche cautioned. Banks are likely to continue to see mounting losses from defaulted loans in the 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 on Jan. 3, 2001, the S&P 500 actually fell 7.3 percent, Stovall said, noting that was an aberration from the norm.
High-priced technology stocks, which at the time accounted for a third of the S&P 500, 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 9.6 percent in that six-month period -- the best performance for any sector. The financial sector outperformed the S&P 500 as well, declining only 3.3 percent.