Once Fed Hikes Stop, Markets Fall

Wednesday, February 01, 2006 | 09:00 AM

As we digest the Fed statement, let's put yet another Bullish Myth to rest:  Markets do not have an upward bias after a rate tightening cycle ends.

Instead, we see the end of a hiking cycle occuring towards the end of a business cycle. That implies if not an outright recession, than at least a significant economic slow down occuring quite often.

What actually has happened at the end of a rate tightening cycle? USA Today commissioned a study from Ned David Research on just that question. NDR's conclusion? 

"Going back to 1929, the Standard & Poor's 500 was actually lower six months after the last rate increase 71% of the time and down 64% of the time 12 months later, according to data that NDR compiled for USA TODAY...

[W]hat the bulls see as an all-clear signal is far from a sure thing. "There's quite a bit of talk about the market doing better once the Fed (stops)," says Ed Clissold, senior global analyst at Ned Davis Research (NDR). "However, more often than not the market has struggled after the last rate hike."

That's not even remotely close to the case promulgated by the Bulls:

Wall Street is betting big on stock prices heading higher once the Federal Reserve stops raising interest rates. But there's no guarantee it will be a winning bet, history shows.

For months, market strategists have been trumpeting the fact that stocks usually rise when the Fed ends its rate-increasing campaigns. Many pundits cite the expected end to the current "tightening cycle," perhaps as early as March, as the key catalyst that will boost stocks.

End of Fed's rate increases may not be good for  stocks


Sources: Ned Davis Research, USA TODAY research


Here's the classic example of the statistically unlikely scenario:

"Jason Trennert, chief investment strategist at ISI Group, says the upward bias in anticipation of the Fed stopping makes perfect sense.

"You have the best of both worlds," he says. "Before the Fed stops, the economy is still performing well, corporate earnings are still good, and the market benefits from the expectations of the Fed stopping."

More of the same Goldilocks story. Allow me to remind you that Trennart -- who is otherwise a nice guy -- has been incorrectly predicting the outperformance of Big Caps over Small and Mid-caps for too many quarters to count, as well as a resurgence of Capex spending for even longer. He's been wrong on both accounts.

There is a silver lining, however:  Since 1980, the Fed has tended to start lowering rates (on average) six months after their final increase.

And falling rates are usually bullish for stocks... eventually.



Odds are that stocks will drop once rate-rising stops

Adam Shell
USA TODAY, Posted 1/29/2006 10:58 PM 

Wednesday, February 01, 2006 | 09:00 AM | Permalink | Comments (12) | TrackBack (0)
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Historically, the best buy-sell decision rule for fed funds is sell when the year over year change is positive and buy when it is negative. It is not a perfect rule, but it works better then any other decision rule on fed policy. But this implies there is a significant lag between the change in policy and the change in the market.

The problem with this rule and the cited study is that it appears to me at least that the market reaction time to economic signals has shortened over time.

When I look at my market index -- a set of buy-sell signals from numerous economic signals --that the lead time is now much shorter then it was 20 years ago.

Posted by: spencer | Feb 1, 2006 9:09:03 AM

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