Once Fed Hikes Stop, Markets Fall

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

[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

"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 

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What's been said:

Discussions found on the web:
  1. spencer commented on Feb 1

    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.

  2. Uncle Jack commented on Feb 1

    I would think the reaction time to rate hikes/drops would’ve shrinked significantly since the Fed starting releasing minutes and actual decisions about rates, which only happened in the last 12 years. Before AG took office it was one big fat guessing game.

    If AG is to be credited with anything it would be the openness of the Fed, even if we sometimes couldn’t understand what he was saying.

  3. calmo commented on Feb 1

    I’m sorta surprised that NDR’s piece gets this coverage, coverage that infects any rules (not matter how deeply writ in stone) or guides about what a termination in the tightening cycle means for the market.
    I’m not saying that we are nothing but lemmings waiting for directions from USA Today but seriously, this is not the placating news we usually get from national media. I’m not saying that all of us are lemmings without our own compass to navigate these troubled waters, but some of us nail-biters have trouble remembering which side of that compass E is on. Of course that is why they (not intrepid us) hand off to the Professional Financial Advisors and they hand off to their whip smart Money Managers.
    Ok, time to savour Jack’s “would’ve shrinked significantly” and his allocade to AG whose literary skills and oratory are much too conservative, rule governed and hoplessly correct to seduce our poetic inclinations.

  4. B commented on Feb 1

    I think alot of people miss the point on here as they defend their position with zeal. We have a holy war of bulls and bears when you should be neither. You should be pragmatic. The world is not coming to an end. Fuggeddaboutit. The US isn’t going to default and the other countries aren’t going to quit buying dollars. It’s great to bitch about but it won’t happen.

    Markets correct for other reasons than recessions and depressions. If you believe we are still working off the bubble, any correction is likely to be done in weeks not years. It may take months to digest or months for a final capitulation from a top but the majority of damage will likely be done swiftly. Especially without a recession on the horizon………yet.

    So, if you aren’t a market timer, you should likely consider putting your money in defensive assets or even plopping it in a 4+% money market until a washout has occured. The market could rally 20% first but odds aren’t necessarily in that camp. Would you rather get a guaranteed 4% or know the cycle is lined up that there are higher probabilities you might lose 10-30% of your capital for the option of limited upside?

    Investing, not gambling, is about lining your investment strategies with high probability gains. That meant, you were a retard if you owned Google into this earnings unless you were in very early. The options activity was stupidly bullish and I could smell that POSSIBLE mess a mile away. Frankly, I’m not sure the action wasn’t preordained. Buying near earnings to take advantage of a 5% pop is best left to professionals who spend their career doing it and know things the average joe wouldn’t dream of knowing.

    Instead, what will likely happen is people will stay fully invested in equities until any correction looks awful, then they’ll sell because the pain has gotten too severe and panic will set in. That’s about the time the market will start going up and you’ll miss it. Double whammy of selling low and buying high.

    Btw, your “financial professional” wants you to stay fully invested because you supposedly can’t beat the market. Phooey. They told you the same thing in 2000 because they collected over $1 trillion in fees from you whether your investments went up or down.

  5. Michael commented on Feb 1

    Oil is creeping up at $69.

    Are we gradually killing the frog in the pot? I hear so little about oil given that we are so close to the Katrina highs.

    Alternative energy, sure. But that is years away. Oil at $69 is today.

  6. B commented on Feb 1

    I hope so. Frog legs are mighty tasty. Raw is better left to sushi and vegetable plates. The sentiment is just plain stupid by any measure. That includes oil too. And there are too many of those taking a leave from their sessions at gamblers annonymous playing in the sandbox.

    These “investment professionals” who are now playing in the oil markets because of the new found wealth potential best be swift traders. Someone is going to be caught without a chair when it’s time to sit down. If the economy slows enough that we continue to build crude, the market with have oil coming out of its ears. That’ll be worse than the nun cracking your knuckles for picking your nose in school.

  7. Michael commented on Feb 1

    Just after I posted $69 oil, it reverses on the day. Interesting…

  8. Ravi Purohit commented on Feb 1


    Has there been any instance ever before where every asset on planet earth traded at life-time highs (adjusted for inflation or otherwise too) at the same time ?

    If that is the case, what would the end of this global rally look like ? Infact, the more interesting question would be – what would end this rally ?

    Warren Buffet had once (or rather has many a times mentioned about how lower interest rates (which they were 2 years ago) change the way we value assets across-the-board. What would have happened, if Federal Reserve had not raised interest rates – a). at all and b) at say half the pace as it has ?

  9. GRL commented on Feb 1

    All of you people are assuming we are now at the end of the rate hike cycle.
    What if you are wrong? What if removal of the word “measured” means they are going to hike by a half point next time?

  10. brian commented on Feb 1


    As to your snark at Jason T. you should when you next appear on K&C demand that when one of your fellow panelists makes a rosy prognostication to either put up or shut up (e.g.: “I will get this prediction right or my employer can fire me”) You being a consultant are of course immune. ;)

  11. Barry Ritholtz commented on Feb 1

    I have this recurring fantasy:

    I’m on some show with one of the PermaBulls — sometime in March 06, during market hours. The other guest is a Joey Baggadonuts type of guy, and talks Uber-Bullish about the Nasdaq or the Semies (which i still think goes higher from here on 2/1, but only for another 4-8 weeks).

    Live, on the air, I say: Sold to you ! I am shorting 100,000 shares of QQQQ — right now at the market price — how many do you want?

    I’ll have my trading desk (Hey David — call Gruntal!) give you whatever you want . . . How many . . . ?

    Then we all enjoy a good laugh as the color fdrains from his face . . .

  12. EclectEcon commented on Feb 2

    The lag between the peak if Fed rates and the downturn provides further evidence that the Fed has problems fine-tuning the economy. They tend to keep raising rates long after they should have stopped, and the reason is that they continue to misjudge and misforecast. Now, if I thought policy makers had rational expectations….

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