Five rate cuts this year by the Federal Reserve Board could be backfiring, according to a Merrill Lynch & Co. strategist.

In a research note issued Tuesday, Richard Bernstein, chief quantitative strategist for Merrill Lynch Global Securities Research, rated the financial stock category just "market-performers," despite the Fed's aggressive rate cutting.

"One would think that financial stocks would at least be significantly outperforming" the market in general, "if not the actual market leaders, under such circumstances," Mr. Bernstein wrote.

Instead, according to his research, financial services stocks on the Standard & Poor's 500 have dropped 4% this year, about the same amount as the S&P 500 itself.

The Dow Jones industrial average rose 0.24% Wednesday, and the S&P 500 gained 0.12%, while the Nasdaq composite declined 0.04%. The American Banker index of 225 banks closed up 0.01%.

Analysts have claimed the financial services stocks were performing so poorly because the Fed cuts had already been factored into their prices, but Mr. Bernstein said he discounts that explanation.

During the three months before the Fed's first cut of the year in January, eight of the 10 S&P sectors outperformed the market, and the financial services sector performed only the fourth-best, he wrote. "Financials clearly did not anticipate the Fed's easing."

Some analysts disagreed with his assessment. "For a long time the [banking] group either held its own or benefited from the money moving out of other sectors" such as technology stocks, said Stephen Biggar, an equity research analyst for Standard & Poor's.

Bank stocks jumped up before the first cut in January, Mr. Biggar said. The S&P bank index rose approximately 25% between late November and early January, but has since retreated.

Mr. Bernstein wrote that though many believed the Fed's easing would spark the beginning of a new economic cycle, such actions may only be extending the late-cycle environment and lead to a recession.

Analysts say that disappointing earnings outlooks and the fear that companies will not meet their second-quarter targets are hampering stock performance. Revenue and profit warnings by J.P. Morgan Chase & Co., Wells Fargo & Co., and Bank One Corp. have added to the concerns, they say.

"Since June started bank stocks have been going down every day because of profit taking," said Marni Pont O'Doherty, an analyst at Keefe, Bruyette & Woods Inc. "And they're just responding to all the pre-announcements."

Mr. Biggar said the two factors that hurt valuations the most are the declines in capital-markets sensitive businesses, virtually all of which is related to the weak equity markets, and the continuing deterioration of credit quality.

Henry C. Dickson, an analyst at Lehman Brothers, said that "people are cautious going into second-quarter" reporting season. "There's not a lot of visibility on earnings, market volume is lower, and volatility is lower. Some of the gains that have been running into the income statements are no longer there."

The Fed's policymaking Open Market Committee is scheduled to meet again this month.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.