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OK, Rates Went Up. Let's Move On.

By PETER MCKAY
Staff Reporter of THE WALL STREET JOURNAL

Now that the fog has finally lifted after the Federal Reserve raised short-term interest rates, many investors have stopped obsessing about rates and started looking at other factors they had been ignoring.

Through most of June, stock trading was light and major indexes barely budged from day to day. For the most part, investors sat on their hands awaiting a rate move. Stocks were then supposed to find a direction after the expected increase of a quarter percentage point on June 30.

But a funny thing happened on the way to the summer rally. Since then the market has stayed sluggish, with the Dow Jones Industrial Average shedding 0.7% in its third straight week of losses, leaving it down 2.3% for the year so far. The Nasdaq Composite had an even rougher week, sinking 3%, and is now 2.8% lower this year.

"We've had this incredible short-term focus lately, which doesn't make sense," says Michael Farr, president of the money-management firm Farr, Miller & Washington. "There are companies out there with good fundamentals that aren't going to change a whole lot just because rates go one way or the other a little bit."

Long View

The bigger picture, according to several cautiously bullish strategists and portfolio managers, is that the course has now been set for a very gradual rise in interest rates, which shouldn't hurt companies that were already well positioned for the long haul. This group includes financial-services companies, certain big-name technology businesses and perhaps even a few downtrodden telecommunications firms.


And with the interest-rate outlook largely in focus, other major issues are stepping to the forefront. Namely, retail sales figures, the pace of corporate-profit growth, rising oil prices and the surging price of gold.

Last week, for example, retailers Wal-Mart and Target said sales in June were less than thrilling and software makers Siebel Systems and BMC Software warned of weak quarterly results. And Yahoo and Alcoa announced quarterly earnings that fell short of what investors had hoped, despite being rather strong. This could become the theme of the second-quarter earnings season: Profits aren't bad, but they are growing more slowly than investors would like.

Oil, meanwhile, rose above $40 a barrel last week for the first time since June 1, after the Department of Homeland Security warned that terrorists plan a large attack in the U.S. before the election.

Cautious sentiment has driven up the price of gold, traditionally a haven during times of investor nervousness. The most-active gold futures rose 2.3% to $407.90 a troy ounce on the Comex division of the New York Mercantile Exchange last week.

The metal is still about 5% off its recent highs in early April. But last week's performance, along with the weakness of the U.S. dollar in foreign-exchange markets, still raised eyebrows among veteran traders in light of the Fed rate increase. Usually, such a move has the opposite effect, pushing the dollar up and gold lower.

Ashraf Laidi, chief currency analyst with MG Financial Group, said last week's moves reflected the idea that -- compared with previous economic cycles -- the Fed's tightening this time around will be particularly orderly, thus not very disruptive to consumers or corporate profits.

Boost for Earnings

If anything, Mr. Laidi says, most currency experts believe the dollar will weaken through the end of the year, keeping U.S.-made goods cheap in foreign markets and bolstering the earnings of multinationals that do much of their business overseas.

Some are predicting a rare event: A rise in both gold prices and the dollar through the end of the year. Usually, the two move in opposite directions, as investors flock to gold as a haven when they're nervous about the value of paper assets, including currency.

"A lot of equity investors probably don't realize it, but the currency markets are saying some things that they should be pretty happy to hear," says Mr. Laidi, who estimates that 25% of the revenue of companies in the Standard & Poor's 500-stock index comes from overseas. "If the dollar stays cheap, that helps them a lot."

In fact, many Wall Street pros say this may be a prime time to buy certain sectors of the market, especially for long-term investors looking toward, say, retirement or a child's college education.

For his part, Mr. Farr is bullish on financial-services companies, even though traditionally they don't tend to do well when rates are rising. He also says certain tech and telecom companies may be attractive, since even a slowed-down economic recovery should create more demand for such products.

For example, he said now may be a good time to buy the electronic-components company American Power Conversion, or Nokia, which is more than 30% off its March high but has introduced a new line of "clamshell" mobile phones that flip open. The company had come under fire for not offering such a product lately.

Other names Mr. Farr is bullish on include Microsoft, Bank of America, and the drugmaker Pfizer -- all of which he owns. He recommends avoiding transportation companies and the manufacturing sector, which is being hit by a prolonged period of high commodity prices.

"At this stage in the economic cycle, this is still a stock picker's market," Mr. Farr says. "You definitely want to choose your spots, but the point is, there are companies out there that are worth taking a look at."

Buy in Baskets

James W. Paulsen, chief investment strategist at Wells Capital Management, advocates a slightly different approach, even though he is similarly optimistic about a gradual pickup in the economy, even with higher interest rates.

He says stocks are still risky enough that investors should buy baskets of companies in sectors that they favor, in order to limit their exposure to a swoon in any one stock. He also recommends buying some short-term Treasury notes, perhaps with five-year maturities or shorter terms, in order to guard against weakness in the broader stock market.

"You've got pretty good fundamentals in the market right now, but great perceived risk, mostly because people are driving forward with an eye in the rearview mirror," says Mr. Paulsen, referring to the recent downturn. "People were so ferociously burned that they're very careful about believing good news."

Write to Peter McKay at peter.mckay@wsj.com



 

 

 

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