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Wall St., Housing Sector Get Warning Shot

Sat January 31, 2004 08:36 AM ET
By Dick Satran

NEW YORK (Reuters) - The Federal Reserve's warning shot was fired with such a muffled tone there might have been a silencer on the weapon -- but Wall Street got the message just the same.

The Fed said it "can be patient" about raising interest rates but decided it could no longer say it would hold rates down "for a considerable period."

In other words, somewhere, sometime, interest rates will rise, the Fed was saying. And don't say we didn't warn you.

Equity strategists were divided about whether this meant a complete reversal for the stock market or just a slight shift in market psychology.

But investors lost no time shifting gears after Wednesday's Fed meeting and they are likely to keep adjusting positions, strategists said. The most interest-rate driven stocks, like housing companies, were getting dumped, while the heavy industry sector held up.

"What the Fed did was completely change the dynamic for the outlook on stocks," said Peter Boockvar, equity strategist for Miller Tabak & Co. "There was this fantasy-land mentality that rates could stay low forever."

FED SIGNALS INVESTORS

The U.S. central bank set the market straight that low-cost money for borrowing by consumers and corporations wouldn't last forever.

"The Fed was letting investors know that the accommodative policy isn't set in stone, and equity investors shouldn't base all their investment decisions on constant liquidity being provided by the Fed," said Jack Caffrey, equity strategist at JP Morgan Private Bank.

Housing was one sector that took the bullet. The Dow Jones housing index (.DJUSHM: Quote, Profile, Research) dropped 4 percent in the second half of the week, and the financial index (.DJUSFN: Quote, Profile, Research) lost 2 percent.

By comparison the broadly based Standard & Poor's materials index, with stocks ranging from DuPont to U.S. Steel, barely moved, shedding less than a quarter of a percentage point.

Caffrey figures that recent improvements in the industrial and material sectors of the economy were behind the Fed's warning. So those are the sectors that investors should start to think about.
Housing was one of the biggest gainers last year as rates hovered at lows not seen for more than 40 years. Real estate, in particular, has boomed. The Dow Jones housing average has climbed nearly 70 percent during the market's upturn. Moreover, rising home values have had a "wealth effect," buoying consumer sentiment and lifting retail sales of housing-related items.

WHITHER HOUSING SECTOR

But does that mean that the housing sector is about to come undone, bringing all of the related sectors down as well? Not necessarily, says Richard Yamarone, director of economic research for Argus Research.

"The housing boom is not really all about low interest rates," said Yamarone. "There are strong demographic trends, with more people entering the home buying age and with an influx of immigrants coming in and realizing the American dream much faster than before."

The leading home builders are saying that demand will hold up as long as mortgage rates stay under 7.5 percent, Yamarone said. Right now, they are 5.5 percent to 6 percent.

But Miller Tabak's Boockvar is skeptical that housing demand will remain as it has over the past year. Even a slight rise in interest rates will take the edge off demand, he said, and that is reason enough to turn bearish on pricey housing stocks.

Indeed, the Fed's lean toward tightening will encourage continued profit-taking in a broad range of stock sectors, Boockvar said, and "in a higher-rates environment this year I don't expect stocks to move any higher."

Still, the economy should continue to expand as momentum builds in sectors outside of housing, especially consumer spending and capital investment, Boockvar said. In an early sign that consumers are getting more optimistic, the University of Michigan Friday reported that its consumer confidence index rose to 103.8 in January from 92.6 in December.

"The consumer remains engaged in the economy," said J.P. Morgan's Caffrey. "But going forward it's going to be less a question of interest rates having an impact and more about job growth and creation."

Consumers "haven't tossed in the towel through a recession, the Sept. 11 attacks and the stock market bubble burst, so I can't see that happening now if interest rates tick up a half-point or a point."

Yamarone thinks that investors have overreacted to the Fed statement, which could have been timed to avoid charges of playing politics closer to election. That could mean it might be many months before the Fed takes any action. "The markets really have it wrong here. I don't think the Fed is going to raise interest rates. I don't see any cause for concern."

For the week, the Dow fell 0.8 percent to 10,488, the S&P 500 slipped 0.9 percent to 1,131 and the Nasdaq dropped 2.7 percent to 2,066.

http://reuters.com/newsArticle.jhtm...storyID=4254726