Fund Managers Have Mixed Reactions To Rate Cut

Some mutual fund managers were jumping into the stock market in the wake of the Federal Reserve's rate cut Tuesday, while others were stepping back to mull what the reduction means for the economy.

"I think the market needed to be shocked, and that was shocking," said Nasri Toutoungi, lead manager of diversified bond fund Hartford Total Return Bond Fund, of the Fed's move. "This was very constructive for equities, obviously; you can see that in the market reaction, but also very good for the fixed-income world for the riskier asset classes - high yield, emerging markets and bank loans - that have suffered a lot. So it's all good if you're positioned that way." The Fed cut its main short-term interest-rate target, the federal funds rate, by 50 basis points to 4.75%, saying that turmoil in the markets posed a threat to economic growth. It also cut the discount rate by 50 basis points to 5.25%. The Fed also said inflation has improved "modestly," but that some risks remain. Stocks jumped on the rate cut, which was deeper than many had expected. The Dow Jones Industrial Average closed at up 335.97 points, or 2.5%, at 13,739.39. Keith Hembre, chief economist at First American Funds, which manages more than $100 billion in assets, had expected a reduction of 50 basis points. But regardless of what the Fed did, he said, the reaction was bound to be big. "No matter what they did, there was going to be a significant market reaction, just on the split expectations going into the meeting," he said, noting that about half the market had expected a 25 basis-point cut, while the other half had expected the larger reduction. Hembre said he expects that many fund managers jumped into the market in the wake of the cut. "I would speculate that managers have been working their way back in leading up to the meeting," he said. "With confirmation of the larger of the two moves that were potentially in front of the Fed, I would suspect that there was a lot buying right after the decision, and it's probably going to continue for a little while here until we get back to focusing more on fundamentals." Hembre noted also that the long end of the Treasury market was selling off. "Holders of longer-term bonds are beginning to get worried about potential inflation risks" with the Fed cutting rates, he said. That's a "standard, knee-jerk reaction," he said, noting that there was a "significant sell-off" in longer-term bonds in 2001 when the Fed made its first cut of 50 basis points, "yet a recession was only a couple of months away." Toutoungi, manager of the Hartford Total Return Bond Fund, said the Fed's move was appropriate, and will reward those like himself who held on to riskier fixed-income asset classes. Historically, when the Fed has eased its rate, riskier asset classes - high-yield and corporate bonds - have done better than Treasurys, he said. "As long as you held your view that fundamentals would prevail eventually, and held on to your riskier asset classes, you are going to continue to be compensated," Toutoungi said. In addition, the steepening yield will provide opportunities, he said. "We expect more of the same continuing steepening of the yield curve, so at the margin, you would be advocating that steepening trade even more," he said. The sister trade would be to buy Treasury inflation-protected securities, or TIPs, he said. "They are going to do better because of renewed inflation fears with the Fed easing."

Strong Dose Of Medicine

Rob Lloyd, lead portfolio manager of the AIM Summit Fund, a $2.5 billion large-cap growth fund, said he was relieved by the Fed's action. "I think the Fed understands that the markets are in dire straits, and he gave us a pretty strong dose of medicine," said Lloyd. He said he was not positioning his portfolio in anticipation of the Fed's action, and hasn't made changes as a result of it, though he's underweight in financial stocks and doesn't own any banks or brokers, the types of companies with the most exposure to the Fed's moves. "I've been positioned very conservatively since the beginning of 2006, when the economy began to decelerate," he said. A lot will now depend on how the economy reacts to the cut, and that could take at least a year to play out, Lloyd said. In coming weeks, he said, his eyes will be on third-quarter earnings reports. With the Lehman Brothers Holdings (LEH) earning report Tuesday, he said, "this was the first earnings that had data from the August credit crunch." The information in earnings in the next several weeks will be critical in seeing if the issues in the credit market will ease, he added. "All of this is going to happen with a lag," Lloyd said. "In the meantime, the companies I do own, I expect to do very well." The fund's three largest sector weightings are currently in energy, health care and technology, Lloyd said. Fundamentals for financials or technology will eventually respond to the Fed cut but, in the meantime, energy, materials and industrials are putting up very strong growth numbers that are minimally affected by sluggish U.S. economic conditions, he said. Mark Mitchell, a manager of the $101 million Security Large Cap Value Fund, said he was surprised by the 50 basis-point cut, and that the challenge now is to interpret the impact on the economy. "I'm not really sure how to interpret what just happened," he said. Mitchell said he had been looking over financial stocks, but noted that a lot of stocks in the sector had moved up more than the broader market in the wake of the Fed action. "From our somewhat contrarian and long-term focus, we would have found more opportunity had the market gone the other way," he said. His next move will be to talk with companies and listen to what they have to say, Mitchell said. "We really need to sit down and understand better what is the Fed seeing and how does that then manifest itself from a bottom-up standpoint in terms of names," he said. Before the Fed's move, Mitchell said, he had been picking through some specialty finance companies, and selectively adding to some industrial names. As for the threat of a recession, Hembre of First American Funds said, "I would say that the risks are as high as they've been since the last recession that there is one on the way." Stocks are up now, but more news is on the way, including the Consumer Price Index and comments from Federal Reserve Chairman Ben Bernanke, Hembre said. "It's a near-term euphoria right now, but before long the markets will get back to focusing on fundamentals."