THE WEEK AHEAD: A Fed hangover?

4 min read

Now that the Fed has cut rates by a full point in less than a month investors turn their attention back to earnings. Historically, tech stocks have flourished following an interest-rate cut but analysts say it’s way too early to predict a similar rebound this time.

On Wednesday, Federal Reserve Board Chairman Alan Greenspan delivered the expected news of a half-point cut in short-term interest rates to match the surprising half-point cut it made less than a month ago.

Investors had an indifferent reaction to the news, most likely because they had already factored in the cut while pushing technology stocks higher in the past month.

On Friday, the Labor Department checked in with a report that the U.S. unemployment rate jumped to 4.2 percent in January, its highest level in more than a year.

More significant, worker wages did not rise at all. Throughout this bull market and subsequent correction, Greenspan has repeatedly pointed to the employment cost index as a definitive measure of an overheated economy.

Traders are already pressing for another rate cut later this month, a possibility that becomes more real with each passing economic report.

"The economy is clearly slowing and you must ask the question, 'Why is Greenspan being so aggressive?'" said Bill Schaff, fund manager for the Berger Information Technology Fund. "And the slowdown is not just the U.S. It's global. There's nothing a business can do. The only question left is the size and the magnitude."

All this brings us back to whether or not these rate cuts will be enough to salvage corporate earnings from leading technology firms.

Steve Milunovich, an analyst at Merrill Lynch, fired off a research report this week suggesting that while tech stocks historically bounce back with vigor following a rate cut, investors must be very selective in these uncertain economic times.

In his report, Milunovich reports that in the past 20 years, tech stocks have risen more than 26 percent in the first year following a rate cut while the S&P 500 Index has improved only 11 percent. He notes that under Greenspan’s watch, tech stocks have shot up an amazing 45 percent in the first year following a rate cut.

“The evidence supports continued share gains, but each situation needs to be analyzed independently,” he wrote. “The September 1998 cut set off a doubling of tech prices in a year. The fundamentals are more negative today, so gains from here may be more limited.”

These cautionary tones have been echoed by CEOs from virtually every sector of the information technology industry.

Reduced sales and earnings estimates, layoffs and even the repricing of employee stock options have become common refrains from the most prolific tech firms of our time.

Conventional wisdom suggests technology earnings will not recover until at least the third quarter of this year, leaving investors with the dilemma of whether or not to buy at these discounted prices despite the uncertainty or pay a premium in the three or four months when the economy picks up some momentum.

“The lesson is that the “wait” or “not to wait” question is related to the investors’ assessment of whether it will be a hard or soft landing,” Milunovich wrote. “Don’t wait if you think it’s a soft landing. So far, it appears that not waiting was the right move for the current cycle. Perhaps we will have a softer landing after all.”

Before everyone runs out and starts buying tech stocks again, it’s worth noting that, according to a BusinessWeek report this week, some Fed insiders are concerned the economy is not close to bottoming out.

“What is most distressing, some Fed insiders say, is that there is no clear sign yet of the economy bottoming out. The next months will be crucial," the magazine wrote.

Only time will tell.

  • Speaking of technology earnings, Cisco Systems will report its second-quarter results next week. Analysts are forecasting a profit of 19 cents a share on sales of $7.22 billion in the quarter.

    Even though the company has advised analysts to lower their sales estimates in the quarter, primarily because of a significant decline in orders in the past eight weeks, analysts are confident the network-equipment giant will at least meet the consensus number.

    Last quarter, Cisco beat the Street view when it pocketed $1.36 billion, or 18 cents a share, on sales of $6.52 billion.

    Investors should expect a cautious outlook from Cisco for at least the next two quarters.

    The stock, trading around $36 a share, is off more than 56 percent from its 52-week high of $82 set in March.