rffrydr
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Joined: 30 Oct 2005
Posts: 16929
Location: Sunny California
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 Posted: Sun Sep 09, 2007 8:28 am Post subject: Buying the Cut |
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| Quote: | Byline: JOHN AUTHERS
When the Federal Reserve cut its discount rate two weeks ago, it was dismissed by many observers as a "symbolic gesture". The discount rate, covering Fed lending to banks, long ago fell out of favour as a tool of monetary policy.
But the symbolic gesture had an impact. By Friday's close, the S&P 500 was up 4.8 per cent after the cut; the Nikkei 225 up 8.5 per cent; and the FTSE 100 up 7.6 per cent. New research suggests this could have been predicted, and cyclical stocks might rally more.
The study by US academics Robert Johnson, Mitchell Conover, Gerald Jensen and Jeffrey Mercer, available from the CFA Institute, shows that the discount rate is a great indicator of the direction of monetary policy. When it changes direction, it signals a shift between expansionary and restrictive monetary policy.
A crude strategy would buy defensive stocks when the discount rate goes up (showing the start of restrictive policy). These are sectors that are not strongly sensitive to the overall economy, such as resources, consumer staples, and utilities. It would buy cyclical stocks (such as consumer discretionary, financials, industrials, and technology) when the rate is cut, signalling easier money.
Non-cyclicals rise 14.65 per cent a year under an expansive policy, compared to 20.3 per cent for cyclicals. But when the Fed is restrictive, cyclicals grow at only 2.25 per cent, compared to 10.24 per cent for non-cyclicals.
From 1973 to 2005, this crude strategy would have beaten the market by 3.78 per cent a year. The discount rate looks a remarkably powerful signal.
The strongest sectors since last month's discount rate cut are as predicted: materials, energy, technology, consumer discretionary and financials. The laggards, as predicted, are defensive: utilities, healthcare and consumer staples.
If - a big if - the economy avoids lasting damage from the credit crunch, the case for cyclical stocks looks strong. |
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