40 year history of FED rate cuts courtesy of Investors Business Daily:
Mutual Funds & Personal Finance
Monday, January 8, 2001
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It’s A Lesson Of History: Don’t Fight The Fed
But there are exceptions to rule that stocks shoot up when rates go down
By Ken Hoover
Investor's Business Daily
It’s hard to imagine anything better to wake up a sleepy stock market than a surprise cut in interest rates. Or two.
Money managers know from experience that interest rates are the main engines that drive the stock market.
"My firm belief is the Fed is in charge," said Fritz Meyer, who runs $200 million Invesco Growth & Income Fund. "When the Fed wants the economy to rally, it can make it happen. Stocks discount upturns or downturns in the economy or in earnings."
Declining rates help the market because fixed-income instruments, like bonds or money market funds, compete with stocks for investors’ money. When rates drop, investors look elsewhere for better returns.
More important, declining rates spur economic growth by making credit easier for consumers and businesses.
That’s mainly what the Federal Reserve had in mind Wednesday when it cut the fed funds rate from 6.5% to 6% and the discount rate from 6% to 5.75%. Then the next day, it lowered the discount rate to 5.5%.
It’s also what investors realized the instant the Fed announcement hit the wires Wednesday. They sent the market soaring — for one day. Faster economic growth brings bigger earnings increases and higher stock prices.
But does this rally have legs? Friday’s market slump makes investors wonder.
IBD looked at every instance the past 40 years when the Fed cut the discount rate for the first time after a round of rate increases.
There were eight times before Wednesday. And in every case but two, the market had already come off a bottom and was rallying. A bull market continued for months or even a few years.
One exception was June 10, 1960. The Fed trimmed from 4% to 3.65%. The S&P 500 dropped another 9.95% through Oct. 25 before a powerful rally began. By then, the Fed had cut three more times, to 3%.
The other exception was Nov. 2, 1981, when the Fed cut the discount rate from 14% to 13%. The Fed had declared war on inflation and jacked interest rates up to record levels. The country was in recession and the middle of a bear market.
The S&P 500 fell another 17.54% until Aug. 12, 1982. But there’s a catch: The Fed waffled in its resolve to get the economy moving. It raised the fed funds rate while lowering the discount rate.
Four days off the Aug. 12 bottom, the Fed pared the discount rate for the fifth time, from 11% to 10.5%. That did it. The market took off like a rocket. The S&P 500 was up 20.2% by Sept. 15. The impressive run-up lasted another 10 months.
Tim Hayes of Ned Davis Research studied every rate cut since the Federal Reserve system started in 1913. He used the discount rate until 1989. Then he used the fed funds rate.
There were 21 first-time rate cuts, by his count. The Dow Jones industrials were up an average of 19.92% a year later.
Rate cuts are like expensive pieces of chocolate to the Fed: It can’t stop with one.
In 17 of those 21 instances, the Fed lowered rates a second time, and in 12 instances a third time. It keeps dropping rates until the economy improves.
Hayes’ research shows the biggest impact comes after the second cut. The market was up an average 28.4% a year after a second cut.
Stocks keep rising on the third or subsequent rate cuts by lesser amounts. When economic activity starts to fan inflation fears again, the market advance peters out. By then, investors are looking ahead to rate increases.
There are exceptions to the rule, Hayes notes.
"There is the exceptional situation where the rate was cut early in a recession. The market didn’t react well," he said.
That was the case in 1960 and 1981. It was also the case in 1929 and 1957.
Hayes also looked at periods after the Fed dropped the rates once and then again after it cut twice.
Out of the 21 previous occasions, in only four did the Dow keep declining until the second cut was made. In every case but one, the Dow rallied, usually powerfully, after the second cut.
The striking exception was an initial discount rate cut on Nov. 4, 1929, right after the crash. The Dow lost another 11.2% until the second cut nine days later. The Dow rallied until April 1930, then tanked massively.
The Fed started another round of cuts on Feb. 26, 1932. The Dow dropped 45.4% before a second cut on June 24. That did it. The Dow was up 113.4% a year later, according to Hayes’ research.
There’s a caveat to all this research. Just because the Dow is up a year after a rate increase doesn’t mean it’s easy to make money.
Many investors remember 1989.
The Fed dropped the fed funds rate for the first time on June 6 of that year and again on July 6. But on Friday, Oct. 13, the Dow fell 190.58 points, or 6.9%. It rallied back until the end of the year, then suffered a nasty 9.5% correction during January 1990. Then the market clawed its way upward until July when Saddam Hussein invaded Kuwait. That sent the market into a tailspin. |
