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Fed and Markets

Posted By Barry Ritholtz On July 27, 2005 @ 7:15 am In Fixed Income/Interest Rates,Markets | Comments Disabled

I rarely find anything to disagree about with Gary B. Smith (Chartman for Bulls & Bears [1], and  columnist on RealMoney [2]) — so when I do, I find it noteworthy. His comments yesterday [3] on the Fed and Markets were exactly one of those incidents:

"OK, here’s a trivia question: Over the past 10 years, when has the Federal Reserve raising rates caused the market to decline?

The answer? Never.

I’ve shown the chart below on a few occasions, but with Fed Talk likely to heat up soon, it’s worth looking at again.

The chart maps out what the market has done over the past decade or so along with what the Fed was doing with the fed funds rate. As you can see, they’ve pretty much followed one another up and down."

>

click for larger chart

Fed_market_impact [4]

chart courtesy of Real Money [3]

>>

What the Chartman is overlooking is that the Fed’s impact on markets
is not typically coincidental — meaning, the result of their actions
does not show up as an instantaneous correlation. Instead, the
causative relationship between what the Fed does and the market’s
subsequent reaction typically includes a 6 to 9 months lag. Just look at he chart GBS used:

In late 1995 / early ’96 — the Fed cut — markets were higher 6 months later;

From late ’99 to early ’00 — the Fed raised — markets were lower 6 months later;

From late ’02 to early ’03 — the Fed cut — markets were higher 6 months later;

I
would explain the delay between the Fed event (cut or hike) and the
reaction simply: the subsequent impact on the economy takes about a
year, and therefore corporate profits take that at least that long to
improve or decay (at least those attributable to Fed action). Hence,
even a 6 month lag in stock prices is anticpating the impact of Fed
action further down the road. The entire process takes a while to work their way through the system.

So where are we today?

From late ’04 to ’05 — the Fed tightened; Let’s see where markets are 6 months later.

>>

Source:
ADP’s Gains Need to Be Processed [3]
Gary B. Smith
RealMoney.com, 7/26/2005 8:35 AM EDT
http://www.thestreet.com/p/rmoney/techforumrm/10234584.html


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URLs in this post:

[1] Bulls & Bears: http://www.foxnews.com/bullsandbears

[2] RealMoney: http://www.thestreet.com/p/index.html

[3] comments yesterday: http://www.thestreet.com/p/rmoney/techforumrm/10234584.html

[4] Image: http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/fed_market_impact.jpg

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