Posted on: Sunday, July 4, 2004

Rate hike seen as mixed blessing

By Adam Shell and Matt Krantz
USA Today

After weeks of agonizing over the Federal Reserve raising interest rates, investors got closure Wednesday when the central bank boosted rates for the first time in four years. But rather than taking time to celebrate, investors have found new things to worry about as 2004's second half began on Thursday.

The big three U.S. stock indexes were almost unchanged in the first half, largely because investors began factoring in how higher borrowing costs, which crimp economic growth, would affect corporate earnings and stock prices. Traders have also been cautious because of concerns about the situation in Iraq and terrorism.

The Fed's decision to raise short-term interest rates a quarter of a percentage point to 1.25 percent, and its statement reiterating its plan to raise rates at a "measured" pace, was viewed as a mixed blessing.

On one hand, traders perceived it as a plus, since it eliminates one of the biggest unknowns haunting investors and allows them to focus their attention on the improving U.S. economy. On the negative side, the tiny increase marks just the first of many rate increases. It also left unanswered the next big question: How big and how many increases will there be?

Christopher Wolfe, equity strategist at JPMorgan Private Bank, says the paralysis that has gripped investors this year may ebb now that the first increase is out of the way and the transfer of power back to Iraqis has been completed. "A lot of the mental hurdles are starting to fall by the wayside," Wolfe says. "As time passes, earnings will grab investors' attention."

Wendell Perkins, chief investment officer of the Johnson mutual fund family, disagrees: "The market is not going anywhere." He says there are few, if any, positive catalysts to drive prices higher. Remaining worries that are likely to drag down stocks include problems in Iraq, a tight presidential race, steadily rising interest rates and a potential rise in inflation.

But bulls are betting on profits to trump those worries. Second-quarter earnings due out in the next few weeks are expected to be stellar. Analysts are betting profit growth for companies in the Standard & Poor's 500 will top 20 percent for the fourth consecutive quarter.

Jack Ablin, chief investment officer at Harris Private Bank, says earnings might start winning the tug of war with rising rates, given that rates are likely to remain historically low for the year's remainder.

Bob Turner, chief investment officer at Turner Investment Partners, agrees. Despite the measly 2.2 percent gain for the Nasdaq this year, investors are likely to refocus on the strong results reported by tech firms. "We think we'll see another leg up in tech," he says.