Charlottesville, Va. (Aug. 17, 2004) -- Is it time to tinker with those portfolios? A study released this week shows that interest rate changes enacted by the Federal Reserve could affect clients' investment portfolios.

The study, "Is Fed Policy Still Relevant for Investors?" -- conducted by researchers from the CFA Institute, Northern Illinois University, the University of Richmond and Texas Tech University -- found a strong connection between U.S. monetary policy and global stock market returns.

During times of restrictive monetary policy -- or rising interest rates -- the markets performed poorly, resulting in lower-than-average returns and higher-than-average risk. Conversely, periods of expansive monetary policy -- when interest rates are falling -- generally coincide with strong stock performance, including higher-than-average returns and less risk, according to the report.

"The Federal Reserve's management of U.S. monetary policy has a strong bearing on the stock market," said Bob Johnson, Ph.D., CFA, executive vice president at the CFA Institute. "While Americans closely follow the impact of rising and falling interest rates on their mortgages, they should also consider the potential effect on their investment portfolios."

Noting that the Fed changed course and adopted a restrictive monetary policy last month, Johnson advised investors to note that "certain sectors are much more sensitive than others to changes in Fed policy on interest rates."

"U.S. monetary policy also has a significant influence on global markets, as evidenced by return patterns for five alternative stock indexes," added Johnson.

Stocks averaged returns of 21.86 percent during periods of expansive monetary policy versus 2.84 percent when Fed policy on interest rates was restrictive, according to the study. While initial analysis suggests that the relationship between the two has lessened throughout the years, the report noted that results are consistent across policy periods, save for a single monetary period in the mid-1990s that coincided with the tech boom.

The study utilizes 38 years of data and examines the relationship between monetary policy and stock market returns by evaluating both cross-sectional and time-series classifications. The cross-section evaluations include investment style by market capitalization and value/growth, sector analysis and country/region. The time-series consistency was evaluated by stock performance during each of the 21 separate monetary policy periods, focused on daily stock returns.

Small cap companies and those in cyclical markets are particularly sensitive to changes in monetary policy, the authors noted. Companies in sectors such as cyclical services, information technology and cyclical consumer goods, which includes the automotive, media and hotel, restaurant and leisure industries, performed 26 percent better during periods of expansive monetary policy. The effects of policy changes were least pronounced for sectors such as utilities and non-cyclical consumer goods, which include food and drug retailers, and food, beverage and tobacco companies.

-- WebCPA staff

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