Wall Street Braces for Rate Hike by Fed on Tuesday
ANNOUNCER: From the world headquarters of CNNfn, the financial news network of CNN, this is MONEYWEEK, with Terry Keenan.</s>LAUREN THIERRY, GUEST HOST: Hello, I'm Lauren Thierry, sitting in for Terry Keenan. Welcome to MONEYWEEK, where we aim to keep you ahead of the curve for the upcoming week on Wall Street. As always, our MONEYWEEK insiders will be here. But first, the Fed meets in a matter of days. Will a 50 basis- point hike be in order? One of the country's most widely held stocks sells off. Cisco Systems loses ground on questions about its high valuation. Microsoft asks a federal judge to throw out the government's proposal to break up the company. And, as always, stock picks for the coming days and weeks. We begin with the outlook for interest rates as Fed policymakers prepare to meet in Washington on Tuesday. A hike in short-term rates is widely expected. Rising rates could, of course, impact everything from your mortgage to your stock portfolio. Concern about higher rates sent stocks sharply lower during the first three days this past week, tech stocks among the hardest hit. But a rally Thursday and Friday helped the Dow to move into positive territory for the week. The Nasdaq, however, posted another weekly loss. The Nasdaq is down more than 25 percent from its March high, putting it well into bear market territory. Investors will have a lot on their plate next week. In addition to the Fed meeting on Tuesday, the CPI, the Consumer Price Index, of April will be released. Also on Tuesday, expect earnings from Home Depot and Hewlett- Packard. And Yahoo! meets with analysts on Thursday. Our team of MONEYWEEK insiders this week say hold on, the volatility will continue. Joining us now is John Manley of Salomon Smith Barney, Larry Seibert, manager of the $16 million technology growth fund for Barrett Associates, and Joe McAlinden, chief investment officer at Morgan Stanley Dean Witter. Gentlemen, welcome back. Let's start with you, Joe McAlinden. We are hearing 50 basis points is the big drum roll right now. Are you in the camp of 50 basis points?</s>JOE MCALINDEN, MORGAN STANLEY DEAN WITTER: Yes, I think 50 basis points probably is what will happen. But I think what's more important is the commentary that accompanies it, which will give the market some kind of expectation then about the next meeting in June and the balance of the year.</s>THIERRY: In other words, how much further do we have to go?</s>MCALINDEN: Right.</s>THIERRY: All right. Larry Seibert, here we had a tame PPI come out today, and we had -- earlier in the week we had retail sales that were moderately lower. Not enough to stop the Fed from raising 50 basis points?</s>LARRY SEIBERT, BARRETT ASSOCIATES: We don't their so. Fifty would be the number that we would pick also. The PPI number this morning did seem to create a bounce, but it was probably more of an oversold bounce than a reaction to the actual PPI number, given the fact that a PPI really is a reflection of commodity prices and not labor -- increases in labor prices, which seem to be creeping into the market here. So we would think 50 would be the number.</s>THIERRY: John Manley, what if the market actually had a negative reaction because the Fed only raised 25 basis points on Tuesday?</s>JOHN MANLEY, SALOMON SMITH BARNEY: See, I think that part of the deal is Mr. Greenspan wants to stay ahead of the curve. He is ahead of curve. He wants to maintain that perspective on Wall Street. And I think that's what's going to happen. We'll do 50 and see what happens after that.</s>THIERRY: What we have seen a lot is we've gotten a tame inflation report in the past, and the markets react by rallying. So in other words, it just heats up the market that Mr. Greenspan so wants to keep down. Why do we keep seeing this see-saw?</s>MANLEY: Well, Mr. Greenspan says he doesn't really care about the market that much, so this is one case I'll take him exactly at his word. I think it's a tough thing. I mean, it's a tough thing trying to keep the economy under control. It's a tough thing trying to keep people afraid. You know, the market always moves on a wall of worry. Fear has sort of kept the economy under control. We have to keep that. It's a tough road for him to hoe at this point in time. I do think the volatility probably helps slow things down. And keep in mind, the bond market has backed up an awful lot in yield recently.</s>THIERRY: All right, John Manley mentioned fear, but, Larry, there's also the greed component of Wall Street here. And when they get any, any, signal that it might be time to rally, they seem to take that signal pretty seriously.</s>SEIBERT: They do seem pretty eager to take that seriously and really rally these stocks. I think in terms of Mr. Greenspan, he's probably pretty happy about the fact that a lot of the air has been taken out the Internet stocks. So that's a positive as far as he is concerned. And many of these stocks probably will never see the highs that they saw in March.</s>THIERRY: In fact, much of your holdings are in tech right now here. We've seen a couple of techs got beaten up pretty badly, but they seem somewhat resistant. How resistant are they these days to rate hikes?</s>SEIBERT: People love to think that technology stocks are somehow unaffected by rate increases. We don't agree. Tech stocks, while they don't maybe perhaps borrow as much money as other companies, if you need to discount the earnings, the future earnings, back to today's rates as rates increase, you have to discount using a higher rate. You should, therefore, be able to come up with a lower price that you're going to buy that stock at.</s>THIERRY: Joe, Larry is setting the scene here for the all- important valuation issue, which has been a huge issue not just in tech stocks, but they have been stealing a lot of the thunder in that department, probably thunder they don't wish to steal right now.</s>MCALINDEN: Our business seems to try to make simple things more and more complicated. Valuation is relatively simple, and it is inversely related to interest rates like a see-saw. And so if interest rates go up, price/earnings ratios go down. And the higher your price/earnings ratio, the more it's going to go down. And so this notion that higher interest rates will have no affect on technology stocks was really a bizarre one, and I think it's been disproved at this point. I think Larry is basically saying that. And I think these further hikes in rates will serve to keep price/earnings ratios at best down to where they have fallen already and maybe push them lower in the case of many of these high-flying growth stocks.</s>THIERRY: All right, the scene is now set. And just ahead, Microsoft rejects the government's proposal to break up the company. Later, we'll tell you how much you would have made if you'd bought Cisco Systems when it went public 10 years ago. You're watching MONEYWEEK on CNN.</s>THIERRY: Cisco Systems was not immune to the technology selling this past week. The stock lost ground following an article in "Barron's" that questioned the company's high valuation. The selling continued on news of a component shortage in the wireless market. The stock is now off more than 20 percent since hitting an all-time high of $80 back in March. And at least one of our insiders says he is not too concerned about Cisco. Larry, that would be you. You -- we all saw the article in "Barron's" a week ago now, and some of us are still reeling from it. You still are a big believer in Cisco.</s>SEIBERT: I'm a believer at the right price. I won't say that I'm not concerned. Cisco's certainly an expensive stock. They made the number. They had a fantastic quarter. Investors took that number and said, well, how much better can they do in the future than that? This seems to be about as good as things can get. But the telecommunications market is growing at an extremely fast rate, lots of new services rolling out over the coming years. Three to five years, we're going to have data devices with very high speeds. We can walk around and get pretty much whatever we want, including this program, while we're walking down the street. So a lot very exciting things going on.</s>THIERRY: It's exciting, but again, Cisco's whole growth strategy has been one of acquisitions, and not all those acquisitions, according to some analysts, have really come out well. John Manley, what do you think?</s>MANLEY: Well, I think it's a great company. I think it's a great company at a great price, and everything -- almost everything has to go right. Two weeks ago, everything had to go right. Now I think if most things go right you're in pretty good shape. You know, one thing you want to avoid is selling the best ones. And I know they're expensive. You know, if you said Cisco: yes or no, I'd probably say Cisco yes. But it wouldn't be my first pick, and I think it belongs in the portfolio with other stocks, and that's the way I'd treat it.</s>THIERRY: All right, Joe McAlinden, you think that the strength in techs has been a lotly -- a lotly? -- a lot based on fantasy?</s>MCALINDEN: Well, I think you had this huge run-up in tech stocks. And a lot of people, particularly the younger analysts, have failed to see how the run-up in the stock prices has reinforced the fundamentals, which then in turn turns around and reinforces the stock prices. And I think this is something that will come home to roost in the next year and a half or so. This is not a next-week or the week after phenomenon. But if higher interest rates deflate indefinitely the IPO bubble, that is going to cut down on a lot of the money that was being raised for dot.coms and other new companies to go out and buy the stuff they need to get in business as a technology company. Well, guest what? A lot of that stuff that they buy comes from the big named companies out there like Cisco and Oracle and so forth. And that creates revenue and revenue growth for them. So aside from the acquisition issues, the accounting issues that were raise in the "Barron's" story, the possibility of a shift from pooling to purchase accounting down the road, which could have negative implication for mean of these companies, a weak technology stock market itself could lead to slower sales and earnings growth for technology companies. A lot of people don't get that. That won't show up for another six or nine months, but that's another shoe that will drop.</s>THIERRY: Got to keep that in mind now. Larry, also Microsoft -- Microsoft and the Justice Department throwing spitballs at each other this week here. In the meantime, Microsoft stock down about 35 percent now since late March. Back then it was trading around 111 here. Now we're about in the high 60s. Your outlook for Microsoft?</s>SEIBERT: The question, of course, is what do you pay for Microsoft since it has traded off a large -- to a large degree. At this price -- we have done a lot work on this unlike many people, and come up with a hold rating. We do like the company. We think Windows 2000 is a great product. They have a lot of opportunities in the server area and the hand-held area. But right now, the risk is extremely high for them. The two outcomes in the near term, either breaking up the company or giving them a list of things they can and can't do when they come in in the morning, neither of those are very positive for the stock near term. But we do like the stock long term.</s>THIERRY: All right, we're going to take a quick break. Just ahead, we're going to tell you why one of our insiders is hot on Lucent Technologies. Stock picks, coming up next.</s>THIERRY: It's time to find out what stocks our MONEYWEEK insiders like. And, John, we're going to start with you. Your top picks are Johnson & Johnson, American Express, and IBM. And now drug stocks have had some trouble over the past year. Why do you like?</s>MANLEY: Well, I think J&J; is a great way to start playing. I think you have a phenomenal story here. Here's a group of stocks that I think have a great secular story. You're going to find a lot of propaganda over the next couple of months as we get closer to the elections. That sort of holds them back. I'll play J&J;, a very high- quality company with a rising growth rate, in our opinion. And I think you sort of periphery into the drug stocks middle to summer, go for more the pure drug plays.</s>THIERRY: IBM?</s>MANLEY: IBM, I like technology. Again, I'm trying to avoid the very high-multiple stuff. I still -- I think Cisco's OK, but I'd rather play IBM's multiple, which is close to a market multiple. Growth rate expectations in the last year have probably gone from 11 to 15 percent. There's a sense of momentum there I like, and you're not paying very much for it.</s>THIERRY: And your third stock?</s>MANLEY: Well, American Express. I want to own brand-name financials. I think we have a great demographic play over the next five to 10 years with the Internet, with consolidation, with people approaching retirement and needing more advice and better advice. Buy the brand-name financials. I think American Express is a good, cheap way to go about it.</s>THIERRY: Follow the demographic there. All right, Larry Seibert, you like three, all of them in the tech area. Let's start up with you: Sun Micro.</s>SEIBERT: Sun Micro would be the most expensive of the three. We like Sun, of course, in the server area. They have some great opportunities going forward. Scott McNealy, of course, is a great manager. And we certainly would be purchasing that stock. We'd like to get it below 80. It drifted above last week, but we do like the name a lot.</s>THIERRY: All right, you've got Lucent on the list here. What do you like about Lucent?</s>SEIBERT: Lucent It is relatively cheaper than its chief competitor, Nortel, though Cisco continues to make inroads into that whole area. Lucent stumbled, of course, at the beginning of the year, missed out on some optical switching opportunities, gave some market share to Nortel. We would not count them out, great R&D.; We like the company.</s>THIERRY: Computer Associates?</s>SEIBERT: Computer Associates would be the value technology play there. They, of course, disappointed the Street a bit by moving out their reporting date, first to the 18th and now they'll be reporting on Monday the 15th. We did not see any news in that announcement. They came out then and said they were going to make the number. A dollar thirteen they should do. A very cheap stick, we really like it.</s>THIERRY: All right, Joe McAlinden, you're not mixing stocks for us, but you do have sectors that you like.</s>MCALINDEN: Yes, I would just -- I'd just add some debate here. I'd be a little cautious on this technology area. I actually like the market here, because if you carve out the technology stocks and look at the non-technology stocks, valuations are fairly close to historic norms. So there's a broad cross-section of stocks that are attractive. In particular, I like stocks in some of these old-economy areas, where pricing power, which is the flip side of the inflation scare, just gets -- keeps getting better and better. So energy stocks, in particular, oil and gas production companies -- the analyst keep raising their estimates on product prices there -- a broad cross- section of basic industry companies. And I like health care, an assortment of health care stocks for a variety of other reasons, including biotech.</s>THIERRY: All right, there we have it. Sectors and stock picks for you And just ahead, we're going to wrap it up with our insiders and get their predictions for the coming days and weeks on Wall Street.</s>THIERRY: All right, we all got this one wrong here. If you had been a true believe in Cisco Systems back when it went public, gentlemen, in 1990, well, Larry, you thought you'd be worth $15,000, putting a $1,000 investment down. You were off by just a few thousand there, I should say, $600,000 being the answer. John Manley, you thought $83,000. Joe McAlinden, you're the winner. You thought $125,000. I went way over the jackpot. I thought I might be a million-dollar baby by this time. So what can I say.</s>MCALINDEN: You were closer than we were.</s>THIERRY: Yes, well, we try. We keep trying. All right, it is time now for predictions from our MONEYWEEK insiders here. And, John Manley, let's start with you. Your prediction?</s>MANLEY: Well, I think over the course of the next six months we're actually going to see a better tone to the market. A great cocktail party statistic: The market hasn't gone down in an election year between May and November since 1948. Usually, the market tends to do fairly well here. I think the Fed will tighten and maybe tighten again, but I think we know about this. I still think we have good earnings numbers and low inflation. That gives you an upward bias to the market. I agree with Joe. Most stocks are pretty cheap. The median P on the S&P; is around 15 to 16.</s>THIERRY: So politics is good for something then.</s>MANLEY: Well, I think politics are good for something, and anything that raises the market is good for me, as far as I'm concerned.</s>THIERRY: Larry, your prediction?</s>SEIBERT: We're actually looking for a pretty normal year, in terms of long-term looking at market. So we're looking for about a 10, 11 percent by the end of the year, which would have been pretty boring in March, but now since we're negative on most indeces isn't too bad a year.</s>THIERRY: All right, Joe McAlinden.</s>MCALINDEN: I think, looking at the Dow, we've got a shot of getting up to the 12500 level before the year is out. It is an election year. I agree with John that the tightenings that we will have are priced into the market. And once the summer hits us, we're going to have a big summer rally. I do want to say, I think Nasdaq will lag the Dow, will not make a new high, and that the real play here is going to be in the Dow-type stocks, the energy stocks, basic materials, health care to some extent, and some of the boring old consumer staple companies.</s>THIERRY: All right, so the tech stocks could get chastised before we know it. Gentlemen, all, thank you very much for your predictions and coming here and sharing with us your insights. Just ahead, a final look at what you need to know for the coming week on Wall Street. "The Last Word," coming up next.</s>THIERRY: Time now for "The Last Word." Joining us now is CNN's financial editor Myron Kandel. And, Mike, a lot on our plate as we go into Tuesday's Fed meeting.</s>MYRON KANDEL, CNN FINANCIAL EDITOR: Absolutely, Lauren. I am still a very lone voice in the wilderness, and I think the Fed will only raise interest rates a quarter of a point for a variety of reasons. Mainly is that Alan Greenspan generally takes a gradual position. OK, but even more than that, we've had -- we've had retail sales in the past week showing they were moderating. OK, that means the economy is not as red hot it was previously. Then on Friday, we got the PPI numbers showing they're way down from the previous two months, OK? And then on Tuesday, before the Fed -- while the Fed is meeting, we will get the CPI numbers -- and I assume they get a little bit of an advanced word. And if the CPI numbers are tame -- and they should be down from what they were a months before -- I think that will give the Fed reason to raise only a quarter of a point. Inflation is under control, the economy is moderating. And just because everybody on Wall Street says the Fed is going to raise a half a point, I don't think they have to.</s>THIERRY: All right, and the three...</s>KANDEL: We'll know soon.</s>THIERRY: ... gentlemen who were just here talking, all of them calling for 50 basis points. Myron Kandel, the lone wolf calling for 25 basis points when the Fed meets on Tuesday. Thanks, Mike. And finally, we'd like to hear from you. Please e-mail us your questions or comments to moneyweek@turner.com. That's all for this week. I'm Lauren Thierry. Have a great weekend.