New material from Eliades: 6% Fed Funds rate is the nail in the coffin
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Message 22343582
<snip>In our newsletter dated June 2nd, 2000, the front page chart was a monthly chart of the Dow Jones Industrial Average going back to December 1915 which used arrows to depict the seven occasions over that period of time when the Federal Reserve raised the discount rate to 6%. Over the years, it has generally been accepted that rising interest rates are bad for the stock market while declining interest rates tend to be good for the stock market. One of the great past masters of market analysis, Edson Gould, formulated buy and sell signals based on the number of times the Federal Reserve raised or lowered interest rates. For example, Gould formulated what he called the “Three Steps and a Stumble” rule with the three steps referring to three consecutive hikes in the interest rate by the Federal Reserve and the stumble referring to subsequent market action.
The current front page chart is an update to the chart of June 2nd, 2000. The last hike to 6% had occurred just weeks before that June 2nd, 2000 newsletter. The repercussions of a 6% discount rate were first brought to our attention by the talented people at Ned Davis Research. In their May 2000 Investment Strategy booklet, they presented a very similar chart with the main difference between their chart and ours being the the additional arrows which they presented on their chart to show where “Three Steps and a Stumble” sell signals were given over the past 80 years. Needless to say, there have been far greater than three hikes in interest rates over the past 3 + years and it would be easy to criticize the Edson Gould theory because the market has failed to pay the price for those interest rate hikes. One could rationalize that interest rates were lowered so dramatically that the interest rate cycle this time around has been very different and that difference has contributed to the market’s benign reaction, at least so far.
The front page chart, however, makes it clear that the absolute level of interest rates has been far more important than the relative rates that resulted from a predetermined number of interest rate easings and hikes. Whenever the Federal Reserve discount rate has moved up to 6% anytime over the past 91 years, it has never failed to stop any stock market rally virtually in its tracks. As you might note from the history of the prior seven occasions of this 6% phenomenon, not only has the market been stopped in its tracks but with only one exception, it has been dealt a blow that would last for several years to come. The one exception occurred at the discount rate hike to 6% on September 4th, 1987. At that time, the market rally once again was stopped dead in its tracks but one could argue that the market was making new all-time highs just two years later and continued to do so over the next decade. There is, however, another side to that story. Within seven weeks of the September 4th, 1987 discount rate hike to 6%, the Dow Jones Industrial average suffered one of the worst crashes in its history and endured a decline of over 40% from its August 1987 high to its October 1987 low.
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