1994 Parallel?

Thursday, December 22, 2005 | 06:45 AM

The delightfully impish Doug Kass ("The Anti-Cramer") looks at the parallels between the 1994 tightening period and the present.

There are bullish implications for using the 1994 Fed tightening template: 1995 - 2000 was (if memory serves) quite a run.

Not surprisingly, Kass finds the comparisons wanting:

  • In 1994, unlike 2005, there was a sharp correction in stocks. While the Dow Jones Industrial Average dropped by only 10% in 1994, many stocks fared far worse. In 2005, equities advanced.
  • In 1994 Edson Gould's 'three steps and a stumble' rule was validated as the Fed tightened. In 2005, Gould's fabled market dictum failed to mark an equity decline, (because the tightening began from historically low levels).
  • 1994's stock market decline was characterized by declining breadth -- far different than 2005's breadth picture.
  • In 1994, the stock market ended the year in a large oversold condition. 2005 appears to be ending with an overbought condition (and unlike 1994, in 2005 certain leadership sectors are particularly extended).
  • Most sentiment measures ended 1994 (that preceded the 1995 market recovery) in deeply negative territory. For example, the put-call ratio (CBOE 10-day) ended 1994 at its highest level of the year. By contrast, the put-call ratio is ending 2005 at its lowest level of the year.
  • The Investors Intelligence survey of bears ranged between 50% and 60% throughout 1994, the highest level since 1982. The Investors Intelligence survey of bears in 2005 has been in the 20% to 30% range, and in December, stands at near the year low of 22%. It is the survey of bulls that stands at 60% now. Markets typically make bottoms and are preparing to rise when they are oversold, investors are bearish and expectations low. These conditions existed in 1994, not in 2005.
  • 1995 was a good year for stocks, but it was an atypical period historically. Even taking into account that year's rally, history shows less inspiring performance.
  • According to Ned Davis Research, there have been 16 separate tightenings over the last 100 years (defined as at least two consecutive rate increases). Surprisingly, the DJIA, on average, has declined by 4.90% in the four-month period following the last tightening date, by 3.90% in the eight-month period following the last tightening date.
  • Today's condition of deteriorating breadth, from record high levels, and breadth divergence (while highs in the indices are being made) stand in marked contrast to conditions in late 1994.

  • Surprsie! Color Kass bearish.


    >


    UPDATE: December 23, 2005 6:05 am

    Nate provides some additional differences:   

    1. Marginal income tax rate increased around 1994 to 39% and stayed at 39% for much of the 1990s (vs. around 35% in 2004). This arguably gave the govt the ability to pay down debt and have low interest rates and inflation during the 1990s economic growth. Low interest rates may be good for stocks. The 1990s economy was strong enough to withstand higher income tax rates, and increases in income tax rates were accompanied by capital gains tax reduction.

    2. Capital Gains Tax Rate: didn't the capital gains tax rate get cut to 20% in the early to mid 1990s? What year did this occur? I know many think taxes do not or should not influence the stock market, yet this tax reduction on capital gains coupled with a tax increase on the highest marginal incomes in the 1990s made stock returns look more attractive to high-income people in the 1990s. This may have influenced people to invest.

    In year 2004, there has been no big improvement in the differential between cap gains and marginal income. A dividend tax cut encourages companies to pump cash out of the corporation, which may be good for management discipline but may not pump up the stock price. The overall impact on capital allocation and impact is unclear and subject to additional debate and research.

    3. Killer New Applications and Growth Drivers - the 1990s had the internet driving change and growth (ebay, Amazon) and supporting industries (Dell). The internet was a very big idea whose time had come. A 2000s equivalent to the 1990s internet may not exist. Apple and Apple's iPod are booming. Others are restructuring.

    >

    Source:
    The Anti-Cramer, Part Deux
    12/19/2005 7:48 AM EST
    http://www.thestreet.com/i/dps/te/20051219/theedge1.html

    Thursday, December 22, 2005 | 06:45 AM | Permalink | Comments (6) | TrackBack (2)
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    » End of Rate Hikes a Catalyst? from A Dash of Insight
    Will the market rally when the Fed has finished the tightening cycle? Is 1994 a good parallel? The Ed Keon interview on CNBC explains it. Look at this summary of the standard story from Doug Kass via Barry Ritholtz, then [Read More]

    Tracked on Jan 4, 2006 10:20:54 AM

    » End of Rate Hikes a Catalyst? from A Dash of Insight
    Will the market rally when the Fed has finished the tightening cycle? Is 1994 a good parallel? The Ed Keon interview on CNBC explains it. Look at this summary of the standard story from Doug Kass via Barry Ritholtz, then [Read More]

    Tracked on May 7, 2007 2:16:31 PM

    Comments

    Barry, I'm a huge fan of your bubble crash analysis document, I regard it as an encyclopedia of the warning signs to look for when things are starting to overheat. How's SMI looking today, and what does it foretell us about the coming year? I've heard you mention other indicators in making your bearish arguments for 2006, but not the SMI.

    Posted by: Anonymous | Dec 22, 2005 9:58:18 AM

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