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The Fed's Move Benefits Mutual Funds

Move over Nick Leeson. There's a new rogue trader in town.

Sure you wiped out $1.8 billion and Barings Bank in 1995 with your fraudulent trading scheme. But that's petty cash compared to the $7.2 billion wallop to Société Générale. Jerome Kerviel, the new record holder for rogue trading, allegedly used fictitious transactions to balance out his unauthorized trading activities.

Ironically, this was a good week for banking stocks and the funds that hold them. This has everything to do with the Federal Reserve surprising the world with a three-quarters of a percentage point rate cut Tuesday morning and the expectation that at least another half of percentage point cut is coming Jan. 30.

Even though the Societe Generale fraud was discovered over the weekend, Bloomberg reported that the Fed may not have been notified prior to its Monday evening conference call, according to an unidentified Fed official. This meant the French banking regulator and Societe Gelerale were quickly closing out Kerviel's losing bullish bets on European stock index futures at the worst possible time of panic selling.

The other major news this week is the compromise between the leaders of the U.S. House of Representatives and the White House on an economic stimulus plan. Even though the U.S. Senate may want to amend the deal, all sides seem motivated to get funds into the hands of American spenders within the next six months. If the stock market really does look six months out based on expectations of economic activity, passage of the stimulus package may help to shift the course of investor expectations.

The 150% positively leveraged ProFunds Banks UltraSector ProFund (BKPIX) won the week with a return of 17.87%. The largest holdings include Bank of America Corp. (BAC - Get Report), Citigroup (C - Get Report), and JPMorgan Chase (JPM - Get Report). The portfolio members gaining the most are Washington Mutual (WM - Get Report)(WM) up 36.04%, FirstFed Financial (FED) up 27.04%, and Colonial BancGroup (CNB) up 26.44%. Along with the positive interest rate outlook, Washington Mutual was bid up on speculation that the company may be acquired.

In second place, the Ultra Financials ProShares (UYG) utilized 200% positive leverage to the daily returns of the Dow Jones U.S. Financials Index to capture 14.86% for the four trading days ending Thursday January 24. As potential takeover targets or bailout candidates, holdings in AMBAC Financial Group (ABK)and MBIA (MBI - Get Report) jumped 81.57% and 56.18% respectively rebounding from their recent routs. That's an amazing return considering that AMBAC reported a fourth quarter net loss of $3.26 billion on Tuesday.

The biggest loser this week is the UltraShort Financial ProShares (SKF). This exchange-traded fund lost 13.46% by betting against the sector with 200% negative leverage.

The only other financial fund to fall for the period is the Franklin Mutual Financial Services Fund slipping just 0.48%. The fund's geographic diversification of 26.2% U.S., 15.2% Germany, 6.8% Norway, 6.6% Sweden, and 5.5 France contributed to the slippage. Aside from a 16.12% loss from Hypo Real Estate Holding AG (HREHY) on subprime related write-offs, the largest downward move of the fund's holdings came from Societe Generale (SCGLY) at -18.48%.

The remainder of the worst-performing list is dominated by funds holding insurance company stocks. The PowerShares Dynamic Insurance Portfolio (PIC) and the iShares Dow Jones US Insurance Index Fund (IAK) did little better than break even.

The concern here is that insurance companies, who are major bond holders, would see their portfolio values decline with cuts in the ratings of bond insurance companies. The counter argument, zeroing out the return for the week, is that insurance companies holding bonds until maturity can weather this volatility.

Best-Performing Financial Funds (Ranked by returns for the week ending Jan. 24)
Fund Ticker Rating Fund Type 1 Week Total Return
ProFunds Banks UltraSector ProFund BKPIX E- Open-End 17.87%
Ultra Financials ProShares UYG U ETF 14.86%
KBW Regional Banking ETF KRE D- ETF 13.04%
iShares Dow Jones US Regional Banks Index Fund IAT D- ETF 12.40%
Regional Bank HOLDRs Trust RKH D+ ETF 11.86%
KBW Bank ETF KBE D- ETF 11.81%
John Hancock Regional Bank Fund FRBAX E- Open-End 11.77%
ProFunds Financials UltraSector ProFund FNPIX E- Open-End 11.59%
Fidelity Select Banking Portfolio FSRBX E Open-End 11.07%
John Hancock Bank and Thrift Opportunity Fund BTO D- Closed-End 10.96%
Source: Bloomberg

Worst-Performing Financial Funds (week ending Jan. 24)
Fund Ticker Rating Fund Type 1 Week Total Return
UltraShort Financials ProShares SKF U ETF -13.46%
Franklin Mutual Series - Financial Services Fund TEFAX D- Open-End -0.48%
PowerShares Dynamic Insurance Portfolio PIC D ETF 0.06%
iShares Dow Jones US Insurance Index Fund IAK D+ ETF 0.24%
KBW Insurance ETF KIE D ETF 0.64%
PowerShares Dynamic Financial Sector Portfolio PFI D+ ETF 1.00%
AXA Enterprise Global Financial Services Fund EGFBX E+ Open-End 1.48%
Fidelity Select Insurance Portfolio FSPCX D Open-End 1.75%
Royce Financial Services Fund RYFSX C Open-End 1.86%
Hartford Global Financial Services Fund/The HGFAX E+ Open-End 1.96%
Source: Bloomberg
Read this for an explanation of our ratings.

Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by TheStreet.com, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.

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SYM TRADE IT LAST %CHG
UYG $144.88 -1.80%
IAK $49.48 0.14%
SKF $50.76 1.80%
SCGLY $9.06 -0.98%
BAC $16.28 1.70%

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DOW 17,854.31 -281.41 -1.55%
S&P 500 2,070.81 -30.23 -1.44%
NASDAQ 4,927.9770 -54.8320 -1.10%

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