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
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
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.