Another Rate Cut

Market Commentary: The Fed cut interest rates by 25bps today. The amount of the reduction was widely expected, and therefore it is easy to conclude that the market got what it wanted. The Fed is lowering rates in an attempt to head off a recession caused by the weak housing market and credit crunch. At the same time, Bernanke and crew are well aware that oil prices above $90 and rising material and grain prices are inflationary ingredients. For now, the FOMC has chosen to try to avoid recession.

We don’t expect equity markets to have an upside reaction of the magnitude they had after the last rate cut. However, some upside is expected if only for the fact that the uncertainty is now behind us. If the Fed action does its job in heading off a recession, then the upside will be justified and the path will be paved for further gains.

The 10-year Treasury yield has been slowly creeping upward the past week from an intra-day low of 4.31% last Wednesday to 4.42% prior to today’s Fed action. Sometimes it takes a few days for the market to fully digest the implications of an interest rate change. However, the immediate reaction suggests that the bond market may be focusing on the inflationary aspects of the cut. The 10-year Treasury yield jumped to 4.47%, and yield gains were evident in 5-year and 30-year securities also.

Sectors: Crude oil hit new highs again this week and closed today above $94 per barrel for the first time. Volatility appears to be part of the equation also as oil prices dropped nearly 4% in a pullback yesterday and then surged 5% today. Energy-related equities have not been keeping pace with crude oil prices, a divergence we would expect to be closed with a rise in Energy equities or a drop in crude. Energy company earnings have generally been quite robust, but executives have been attempting to dampen future expectations.

Styles: The market continues to favor Growth over Value. The dispersion between the two is not nearly as large as can be seen in our sector or global rankings, but it is definitely a factor in the current environment.

International: One day the story will change, but for now, it seems to be the same week after week, and month after month. China is providing the global growth leadership. Other Emerging Markets are close behind. The world’s three largest developed markets – USA, Japan, and the UK – are lagging. The US dollar remains weak versus other currencies and hit a new low against the Euro today, which provides an additional boost for the international holdings of US-based investors.