Financial stocks usually benefit across the board when the Federal Reserve cuts interest rates, but the joy might not be shared equally when the Federal Open Market Committee makes a decision Wednesday about whether to ease rates, market observers say.
Its difficult to generalize this time around, said Sung Won Sohn, chief economist at Wells Fargo & Co. While investment banks and money centers are likely to see their shares rise, thrifts and commercial banks that depend on consumer deposits could feel less of an effect, he said. Surprisingly, stocks of banking companies that have credit problems including Hibernia Corp., Bank One Corp., and Bank of America Corp. have been trading higher.
David Berry, director of research at Keefe, Bruyette & Woods Inc., said the upward trend in these riskier stocks would continue only if the Fed makes a 50-basis-point cut rather than a more cautious 25-point trimming.
The American Banker index of the 50 largest banks rose 1.49% on Friday, and its index of 225 bank stocks rose 2.1%.
Adjustable-rate lenders margins could be squeezed, because a decline in the cost of funds does not immediately compensate for lower income on certificates of deposits and home equity loans, Mr. Sohn said. It really depends on the balance sheet and the asset-liability techniques.
Francois Trahan, a sector strategist at Brown Brothers Harriman, argued that financial stocks are generally more affected by long-term interest rates, which, given the recent rally in bond prices, could rise rather than continue to slump.
He said a rate cut would not be enough for financial stocks to benefit and speculated that the widely anticipated rally in financials could be short-lived as investors move into cyclical sectors including retail and equipment manufacture.
Mr. Trahan advised investors to think about an exit strategy for stocks that are most affected by the yield curve, such as savings and loan institutions. Its time to move into brokerages and companies with diversified revenue streams, he said. He also recommended consumer finance companies.
Experts agree that money centers and investment banks stand to benefit most from a rate cut. A cut makes recession less likely, which lifts the dark cloud of credit problems and promises to boost revenues from activities such as lending, stock and bond underwriting, and merger-and-acquisition advisory.
The investment banking business generally picks up in a lower-rate environment, Mr. Sohn said, and broker-dealers and other capital markets players stocks should rise.
Mr. Berry said that he was less bullish on some superregionals and is having a hard time finding bargains in the sector.
Any jump in financial stocks should not be as dramatic as the one that happened Jan. 3, the day of the Feds surprise move, said Mike Seiler, senior vice president of Capital Resources and a portfolio manager at the hedge fund Aldie-Partners.
He said the market would have an overt negative reaction if the Fed confounds expectations by leaving rates alone.