From Chart of the Day

The Federal Reserve raised the fed funds rate from 2% to 2.25%.  The charts below provide perspective to the current interest rate environment relative to the stock market. The bottom chart illustrates that while the fed funds rate has been rising as of late, it still remains well within a long-term downtrend. The top chart illustrates how the market performed following significant tops and troughs in the fed funds rate.

Cod_spx_20041215_2

Cod_fed_rate_20041215b_1

 

CoD observes: "The stock market’s performance has been less than stellar following
major troughs in the fed funds rate (see red arrows). There is logic to
this relationship since rising rates increase both the cost of debt and
the relative attractiveness of interest bearing investments."

I would add a few caveats:  First, trend channels tend to work because of Humans buying stocks when they come back to the point they previously missed them at ("if only I bought XYZ when it was at $Z"), or selling them once they get back to a previous higher level (as in "puh-leeze let me get back to break even!").

I’m less convinced charting is as effective at predicting investor behavior when controlled for the Fed.

Second, this is a very long term chart, and timing entries based on a chart that encompasses decades is a bit tricky. The Fed tends to cut after the economy has shown clear signs of slowing or recession. The markets usually get worse from that point on before they get better. The inverse is also true — the fed raises rates when the economy is getting hotter. Stocks tend to do well — until they peak and reverse.

Category: Economy, Markets

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2 Responses to “Fed fund rates versus SPX”

  1. spencer says:

    On average, since WW II in bear markets the s&p 500 PE falls by about a third while earnings rise at single digit rates. In the first year of a recovery the PE rises about a third while earnings fall at single digit rates.

    So what drives the market is whatever causes the PE to fall and rise. That is monetary policy, long bond yields — not necessarily the same thing — inflation and the risk premium.

    If you look at this historic record you can see why the stock market is strongly influenced by fed funds.

  2. Chibi says:

    Pretty interesting, and I think this is generally what Warren Buffett was getting at in his article in Fortune a few years back. Seeing that the downward channel on the Fed funds rate is running out of room, a new upward channel should form at some point, no? Disclaimer: I am pretty ignorant of technical analysis.