Fed and Markets

I rarely find anything to disagree about with Gary B. Smith (Chartman for Bulls & Bears, and  columnist on RealMoney) — so when I do, I find it noteworthy. His comments yesterday 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


chart courtesy of Real Money


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;

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.


ADP’s Gains Need to Be Processed
Gary B. Smith
RealMoney.com, 7/26/2005 8:35 AM EDT

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  1. spencer commented on Jul 27

    Partl of the answer to this probem is the behavior of the long bond yield. Prior to 1990 fed funds and long bond yields moved in lock step so a fed tigtening was accompanied by rising long rates. If you forecast rising rates it did not matter if you were forecasting long or short rates. But since 1990 the tight correlation between short and long rates has broken down and a rise in short rates or fed tightening no longer assures a rise in bond yields.
    If you look historically, it is bond yields, not fed funds that drives stock PEs and the stock market. Moreover, this has been the case since 1990 and if you look at the periods in the charts you did not see big increases in bond yields when the fed tightened since 1990.

    This has happened because of the shift in the US dependence on foreign capital. Now, foreign bond yields have replaced fed funds as the major determinate of domestic bond yields and the stock market.

  2. james commented on Jul 28

    i would venture to say that Mr. Smith is using spurious correlations to prove his point. In my mind, the 95-00 bull was secular and not cyclical (i will also make the statement that the entire bull run from 82-00 was secular – so the fact that, again, in my mind, Mr Smith “cherrypicked” data practically proves your point barry). My question then is, what happend in 82-90 Mr. Smith? Where is your graph then? And why only study one time period? C’mon Mr. Smith – even 2 bit traders know how to back test for different time periods and economic conditions and compare each – and then try to interpret our current environment. One patient under study would hardly get an FDA approval – yet so many fall for this kind of economic reasoning in the stock market. Each secular “trend” is born of completely new conditions – if it were not, would it not be cyclical? So why just look at one “trend” and then try to extrapolate into the future beyond?

    yes……….reading econ blogs always helps me get sleep, but not barry’s – obviously!

  3. Barry Ritholtz commented on Jul 28

    I don’t think it was even cherry picking — he merely took the last 10 years — but your point is well taken.

    Any type of statistical analysis requires a broad data set — and not one solely from a secular bull (or bear) market

  4. Neal Greenberg commented on Feb 8

    does gary b smith have his own website now that he is not with thestreet.com


  5. Brandi commented on Feb 12

    It’s early and it makes my head hurt trying to figure out what you’re trying to say here. Gary thinks the fed raises the markets go up. I like it simple.

    *Betting against gary may be hazardous to your portfolio*

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