Utility, drug stocks set to gain from rate cut

LONDON (Reuters) - Investors are likely to buy shares of European utility companies, drugmakers and food firms following any U.S. Federal Reserve interest rate cut, if history is any indicator.

There could also be opportunities among bank stocks as a result of a recent battering financials have endured, while the fate of cyclical stocks could depend on whether a cut, widely expected from the Fed at 1815 GMT, is seen as the first of several to come.

A decline in U.S. employment has put pressure on the Fed to cut rates, and 19 out of 20 primary dealers polled earlier this month forecast a cut, with 15 saying that rates would be cut by 25 basis points and four pegging the cut at 50 basis points.

Whether cyclical stocks out do defensives after a cut depends on whether or not the cut is the first in a series, analysts say.

Only a series of cuts -- or a signal that we are entering a regime of interest rate easing -- could benefit cyclicals as it prolongs economic growth.

Defensive stocks, or safe bets that are insulated from economic swings, have done well in recent times after a cut.

"There will not be a major pro-cyclical shift. We have to see evidence that the Fed's policy is successful," said Credit Suisse strategist Andrew Garthwaite.

Credit Suisse said in a recent note that European pharmaceuticals had risen 8.7 percent on average in the six months following the last five Fed cuts, with food companies gaining 6.8 percent and utilities gaining 5.3 percent.

Foods and utilities have outperformed the broader market so far this year, but drugmakers and banks have been significant laggards.

While the pharmaceutical companies have been hit by negative product news and increasingly sparse pipelines, banks have been taken lower by investor concerns over their exposure to a crisis in the U.S. market for subprime, or risky mortgages.

"Normally financials would also gain from a cut in rates, but people may say: 'so what if they cut rates? it's more to do with subprime and with confidence' and sell into a rally," said Andrea Williams, head of European equities at Royal London Asset Management.

DEFENSIVES FAVOURED

With equities as a whole taking a hit from ructions in the credit markets, investors have switched to defensives.

Since mid-July, European banks have lost 13 percent in value, while foods, utilities and healthcare have all lost less than 4.5 percent and fared better than a 8.5-percent fall in the broader market.

"Industrial cyclicals will do well, but consumer cyclicals could be vulnerable still due to personal income and job creation," said Brewin Dolphin chief strategist Mike Lenhoff.

"I'd buy some cyclicals such as miners and industrial cyclicals like aerospace, but also defensives like pharma, utilities and beverages."

Equity valuations this time round are also less demanding than in the past, analysts say.

Lehman Brothers said in a note that short rates and stock returns had been uncorrelated historically but that turning points in a rate cycle had been an important influence on the market.

"If history repeats, and the Fed cuts as expected, the S&P 500 should be at 1,531 by year-end. Our forecast is higher, at 1,600, because valuations are more attractive than in past easings," it said.

The S&P 500 ended Monday at 1,476.65 points.

The pan-European FTSEurofirst 300 index of top European shares has fallen 8 percent since hitting a 6-1/2 year peak in mid-July, and Brewin's Lenhoff said this high was looking very distant.

"If the Fed cuts rates, any rally will be capped by a realization of why they've cut," said Lenhoff.

"There will be an initial rebound, but shares are not going to reach the levels seen in July."