BUSINESS/FINANCIAL DESK

Advice for Investors: Don't Panic Over Rates

By ALEX BERENSON (NYT) 954 words

Interest rates are going up, but unless inflation suddenly becomes a much more serious problem, they will do so only moderately, analysts say. As a result, the increases will probably not derail economic growth or corporate profits, which are soaring. And barring an unexpected shock like a terrorist attack or a big increase in oil prices, both the economy and the stock market appear reasonably healthy, they say.

''Interest rates are going up for a good reason -- a stronger economy -- and that means higher corporate profits,'' said Sung Won Sohn, the chief economist for Wells Fargo, a bank based in San Francisco. For the next several months, those rising profits should provide a crucial lift for stocks, Mr. Sohn said.

After rising sharply in 2003, stocks have been remarkably steady this year. The Standard & Poor's 500-stock index, which includes nearly all the largest stocks, has not fallen below 1,084.10 or risen above 1,157.76 this year, a range of 7 percent. It closed Friday at 1,134.43, down 6.22 points for the day and essentially flat for the week. For the year, the S.&P. 500 has risen 2 percent, while the Nasdaq composite index is up 1.1 percent and the Dow Jones industrial average has fallen 0.8 percent.

Long-term interest rates are already rising, which ordinarily would hurt stocks, but this year soaring corporate profits have countered that effect, said Lee A. Scundi of Stevenson Capital Management, which manages more than $200 million. Profits at S.&P. 500 companies are expected to rise 14 percent this year and an additional 10 percent next year, according to Zacks Investment Research.

With the S.&P. 500 expected to have aggregate profits of $61.19 a share in 2004, the index is trading at about 18.5 times earnings, which is just above the historical average. But considering that interest rates are still very low by historical standards, stocks have room to move higher as corporate profits rise, Mr. Scundi said.

Once investors see for themselves that rising rates are having only a minor impact on growth, stocks will rise, he said. ''As for the second half of the year, I think it's going to be a lot stronger than the first half.''

For a year, the Federal Reserve, the nation's central bank, has kept the federal funds rate, the rate charged on overnight loans of bank reserves, at 1 percent, its lowest level since the late 1950's. The Fed controls short-term rates through the federal funds rate, raising it when inflation seems to be rising and lowering it to give the economy a lift at times when it seems weak. Higher interest rates raise borrowing costs for consumers and businesses, which causes them to cut back on spending and thus slows economic growth. Lower rates have the opposite effect.

For 2002 and much of 2003, the economy seemed to be sputtering, growing slowly and failing to create jobs. But years of ultralow interest rates and big government deficits appear to have provided the monetary and fiscal stimulus the economy needed to get back on track.

On Friday, the Commerce Department reported that the economy had grown at an annual rate of 3.9 percent in the first three months of the year, lower than its original estimate of 4.4 percent but still healthy. Inflation rose at an annual rate of 2.9 percent, above the original 2.6 percent estimate.

With prices creeping higher, the Federal Reserve has been signaling for months that it plans to begin raising short-term interest rates to make sure that inflation remains under control. But Alan Greenspan, the chairman of the Fed, has also said repeatedly that he does not think inflation is currently a severe threat. So most professional investors expect the Fed to raise rates only moderately, slowing the economy slightly but not derailing the recovery that has gained strength over the last year.

The consensus estimate is that the Fed will raise the federal funds rate a quarter-point on Wednesday, to 1.25 percent. One or two more quarter-point increases are expected before year-end, and more are expected in 2005.

Even so, most analysts expect the funds rate to remain below 3 percent for the foreseeable future, low by historical standards. As a result, interest rates on long-term bonds have also stayed very low by the standards of the last 30 years. The yield on the 10-year Treasury note has risen from 3.68 percent in March to 4.65 percent on Friday, but that yield is extremely low. Over the last 20 years the yield has averaged more than 7 percent, and rose as high as 13.8 percent in 1984.

Long-term rates may rise further this year as the Fed increases short-term rates, Mr. Sohn said, but the increase will be moderate, so bond investors have no reason to panic. He predicts that the yield on the 10-year Treasury note will reach 5.2 percent by year-end.

CAPTIONS: Photo: Sung Won Sohn, right, the chief economist for Wells Fargo, said, ''Interest rates are going up for a good reason -- a stronger economy.'' (Photo by Bloomberg News)(pg. C8)