Interest rate cut moves telecom

The Federal Reserve’s surprise interest rate cuts may once again entice investor back into the ailing shares of telecom service providers.

For one day at least, that seemed to be the case. The Nasdaq jumped 324.83 on Wednesday, or 14.2%, to end the day at 2616.69, showing record point and percentage gains. More than 3 billion shares were exchanged, making Wednesday the busiest trading day ever on the Nasdaq. Although the index gave back some of its gains in trading today, most telecom stocks seem to be holding on to yesterday’s large advances.

“The 50-basis point cut takes time to penetrate the economy, and there’s no doubt that there is further economic weakness ahead,” said Peter Cardillo, director of research and chief strategist at Westfalia Investments. “But many [telecom] stocks are already selling at recession levels and have no place to go but up. I’ve been buying them all along.”

The Fed cut interest rates for the first time in two years, lowering the discount rate by one quarter of a percentage point to 5.75%. The Federal Open Market Committee also lowered its target for the federal funds rate by 0.50% to 6%. And the Federal Reserve’s Board of Governors stands ready to approve a further quarter-point reduction of the discount rate on the request of Federal Reserve Banks.

“These actions were taken in light of further weakening of sales and production and in the context of lower consumer confidence, tight conditions in some segments of financial markets, and high energy prices sapping household and business purchasing power,” said a press release from the Federal Reserve.

The surprise move—the Fed wasn’t supposed to meet again until the end of the month—gave the shares of long-distance carriers their best day in a while. WorldCom shares surged more than 25% Wednesday, while Sprint and AT&T enjoyed gains in excess of 10%. Sprint and AT&T continued to edge up today, while WorldCom shares slid about 3%.

Next-generation carriers XO Communications and Global Crossing posted increases of about 25%, while the RBOCs, which have weathered the bear market better than other telecom stocks, all advanced and continued rising in midday trading Thursday.

“[Telecom stocks] could regain market leadership as interest rates are cut further,” Cardillo said. Although the advances will be gradual for now, Cardillo said investors should expect a strong comeback in the second half of 2001 as profit outlooks brighten.

Other investment strategists also applauded the move by the Federal Reserve but cautioned against over-exuberance. Abby Cohen, chief U.S. portfolio strategist at Goldman Sachs, said the cut “significantly reduces the risk of an unintended recession,” but that Goldman Sachs was making no changes in its recommended asset allocation nor changing its year-end price forecast for the S&P 500. Cohen said there is about a 20% upside to the S&P 500’s current level.

Corporate earnings in 2001 could put a bit of a damper on any long-term rally, as operating earnings will grow at “mid-single digit levels as opposed to the much more rapid earnings growth rates that people are accustom to,” Cohen said. “The [fed] action was warranted but it is just one piece of a bullish case for the equity market,” she added.