Further Fed rate rises likely

Board members indicate no quick end to anti-inflation effort

October 11, 2005|By WILLIAM SLUIS | WILLIAM SLUIS,CHICAGO TRIBUNE

For investors who worry about rising interest rates, what comes next may well be the tough part.

Despite 11 increases in short-term rates in just over 15 months, Federal Reserve members are indicating there will be no quick end to their campaign to tighten credit.

Don't be surprised if the central bank makes at least two more interest-rate moves before Fed Chairman Alan Greenspan departs in late January, which would bring its short-term lending barometer to 4.25 percent, said Bannockburn, Ill.-based mutual fund manager Henry Van der Eb. Other economists say the rate could hit 5.5 percent next year.

"Greenspan's parting shot will be to go out as a hard-money anti-inflationist, and he is specifically targeting the housing bubble," said Van der Eb, of the Gabelli Mathers Fund. "Until now, Greenspan has been far too free with the money supply."

Remarks in recent days from Fed policymakers indicate "the central bank clearly is at the high end of its range for the level of inflation it will tolerate," Van der Eb said.

For now, stocks continue to tread water. Through the first three quarters, the Standard & Poor's 500 index was up slightly for the year, and stocks in the Dow Jones industrial average lost about 2 percent.

A narrow list of stock groups has done the year's heavy lifting, notably energy stocks, which have soared 40 percent; utilities, which are enjoying a me-too rally; homebuilders; and some health care stocks. Technology stocks have gained about 10 percent, as have small-caps.

Stocks to shun have included banks and other financial issues. A broad range of consumer stocks has seen ho-hum results for the year. And retailers have been torpedoed in the wake of Hurricane Katrina, as investors fret about sky-high gasoline costs, which could hamper holiday shopping activity.

So where should an investor place money now? Investment manager Brian Wesbury says that despite the long series of Fed increases, stocks remain undervalued by about 30 percent, according to historic measures.

"Investors have priced just about every kind of disaster into the market, but the outlook remains favorable," said Wesbury, of Claymore Advisors in Lisle, Ill. "Even though the Fed likely will continue to boost interest rates to ward off inflation, pessimism has been way overdone."

In the months ahead, he sees good investment opportunities in cyclical stocks, including manufacturers.

"Cyclical stocks have been hammered, but there is every likelihood that energy prices will come down in the wake of excessive speculative fervor," Wesbury said.

"Tech stocks have been great, and there is a chance they can really get on a roll," he said

Wesbury also believes stocks of retailers will rebound. "They will come on strong as energy prices come down," he said.

In recent days, there has been a shift by investors in the direction of large, high-quality growth stocks and away from utilities and energy or materials stocks, said Chicago investment manager Marshall Front.

"People sense that as the Fed takes steps to slow the economy, it's a good time to hold shares of well-managed companies with prospects of sustained earnings growth," he said.

That grouping includes major technology companies that have seen their shares erode, even though they are sitting on giant reserves of cash, said Front, of Front Barnett Associates.

"Some of these tech stocks are trading for earnings multiples lower than the overall market," he said. He also likes some large retailers, industrial firms and companies that provide popular consumer staples.

Other analysts are cautious, and believe the Fed could push too hard in raising rates and limiting economic growth.

"Money could shift out of the stock market into fixed-income instruments and certificates of deposit, where there has been no meaningful reward for investors in many years," said Chicago banker Kenneth Skopec of MB Financial Bank.

He believes that uncertainties about the economy mean that "everybody needs a bit of breathing room" in the Fed's monetary tightening campaign. In other words, it's time for the central bank to take a pause.

Otherwise, Skopec said, "there is no question that higher rates will inevitably harm the construction industry."

William Sluis writes for the Chicago Tribune.

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