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Stock Market Rallies & Fed Rate Policy

11/20/2013
By Charles Payne

Much is being made about this stock market rally and how it's not real and just another bubble ready to pop.  While such skepticism is warranted based on lingering feelings of being burned, there is no doubt there are other factors influencing such disbelief.  In fact, too many people worry that anything that's complimentary to President Obama gives him more power or influence.   While there is no doubt most Americans believe the stock market is a pure reflection of corporate profits made only in America, a rally isn't enough to erase the realities of their own lives.

 In fact, since the start of the year, the stock market has gone straight up, while President Obama's approval rating as measured by Rasmussen has plummeted (51% from 57%).

Dow Jones Industrial Average

President Obama

+9%

-11%

I've argued that the rally is more than justified based on corporate profits, but those profits reflect growth in the rest of the world.  This is a fact not up for dispute, and a fact that not only Main Street does not understand, but giant swathes of investment professionals do not understand.  It's not hard to find if one looks at a bunch of earnings releases and income statements.  Heck, for many, there isn't a company more important than Kentucky Fried Chicken, but the share price of its parent company, Yum Brands, rises and falls on the news out of China.   The 30 names in the Dow Jones Industrial Average are for the most part global companies, with many including the most influential, IBM, gaining more revenue and profits from aboard.

With respect to what drives stock prices, in a perfect world absent from any form of manipulation, which may have last been in the late 1960s, is the expansion of margins, which results in robust moves in earnings.  Innovation that leads to pricing power and market share gains is the primary driver of expanded margins.  In many of the nations of the world where wealth is increasing, American made or American engineered products are more desired than the old stuff locals once used.  Now, these people can afford that stuff, and they can't get enough Whirlpool washers and driers in Latin America, and China must have Caterpillar tractors to attain its goal of becoming the most powerful country in the world.

I get that the average man or woman on the street doesn't understand this or may still think everyone in Azerbaijan are poor goat herders rather than  a country that is a hot spot for a race of new luxury hotels.   What bothers me is how many so-called professionals dismiss the impact of the (former) third world becoming upwardly mobile and attainting certain tastes that luckily American companies can satisfy.  Still, many look at Main Street and see mostly despair.  Even after 236,000 jobs were created in February, the overwhelming feeling is this is a hard time for the nation.  That feeling is correct. In fact, the jobs report saw a few short term pluses that barely dented the longer term negatives.

Positives

February Report

Construction

Professional Services

Information Industry

+48,000

+73,000

+20,000

Negatives February Report

Unemployed

Dropped Out

27 Weeks +

12,000,000

130,000

4,800,000

 Coupled with the fact that there is a new class of Americans that once worked and had a sense of pride, is the fact millions have lost their homes over the past half dozen years and 14,000,000 homes are still underwater.

There used to be a time when the market rallied and good news followed soon after, but that was when the market was a harbinger of what was to come- an oracle of sorts.  That reputation was washed down the tubes when the Dow peaked one month before the start of the Great Recession.  There is a chance, however, that this market is perfectly set up to lead a rebound in the economy which has the benefit of climbing off a low base. That low base is a giant mountain of doubt and frustration for Main Street.

Interestingly, if there is sustained traction in the economy, people will come back into the job market reversing one of the most desperate traits of this flaccid recovery.  Nearly nine million people have dropped out of the jobs market.  If they come back with any vigor, even net job gains will be accompanied with higher unemployment rates, which actually keep the Fed farther away from its target of 6.5% unemployment.

One day, the Fed will hike rates, and that is when so many pundits say the rally collapses- history doesn't agree.

Stock Market Rallies & Fed Rate Policy

Oct 1990 - Jan 2000 Bull Market

In the midst of a serious bull market, helped in part by lower interest rates, the Fed removing the punch bowl often only has a temporary impact.  The most amazing rally of this generation began on October 11, 1990, and finally ran out of steam on January 14, 2000. The Dow stood at 2,365 when rally began in the midst of a series of Fed interest rate cuts that began earlier that year on July 13.  The Fed started on an aggressive rate-cutting program that saw Fed funds go from 8.25 to 3.00 before seeing the first hike on February 4, 1994, of 25 basis points.

The Dow tumbled 7.2% to 3,593 in an instant knee-jerk reaction that lasted exactly four months before resuming the move higher.

The Fed hiked rates in 1995, by this time lifting the Funds rate to 6.00, but shifted gears to hike rates twice more that year.  That hike came on March 25 with the Dow at 6,876 resulting in a swift decline to 6,391 or a 7.0% decline in less than a month.

The Fed cut rates once in 1998, by then the stock market was on autopilot and a mania had begun where everyone thought the party would never end buoyed by the notion of a paradigm shift that not only changed technology, but all aspects of our lives.  Around this time, I remember famed investor, Jim Rogers, grumbling about the situation, but he chose to not fight the trend stating to me: "the market can stay irrational longer than I can stay solvent."

By 1999, the Fed hiked rates three times, the first on June 30, and the Dow actually edged higher.

The Fed hiked rates three times in 2000.  The Dow peaked on January 14, 2000, at 11,612.  What ensued was akin to the wild times of the Great Depression that saw 13 separate bull and bear markets.  The first dip saw the Dow slip to 10,376 over the next five months for a decline of 10.6%.

The irony is the Dow went into full free-fall mode in 2001 even as the Fed went into full emergency-mode with 11 interest rate cuts.  In fact, the Dow peaked at 11,122 on June 24, 2001, more than a year after the last interest rate hike.

Fed Action During Rally

Rate Cuts

Stock Market Reaction

 

July 13, 1990

Fed cuts 25 bps to 8.00

Fed cuts five times this year

The Dow finishes session at 2,980 and Bull Market begins October 11 with Dow finally bottoming at 2,365

 

Fed cuts rates 10 times in 1991

Fed Fund Rate finish year at 4.00 market rally full steam ahead

Fed cuts rates three times 1992

Fed Fund Rate finish year at 3.00 market rally full steam ahead

Rate Hikes

Stock Market Reaction

 

February 4, 1994, Fed hikes rates 25 bps to 3.25

Fed hikes rates six times this year

The Dow slips from 3871 to 3593 as a knee jerk reaction by April 4

 

February 1, 1995, Fed hikes rates 50 bps to 6.00

Fed cuts rates 25 bps July 6 & Dec 19

Rally continues to edge higher and picks up head of steam

March 25, 1997, Fed hikes rates 25 bps

Dow dips to 6563 from 6876 or 4.6% before turning higher

 

June 30, 1999, Fed hikes rates 25 bps and three times this year

The market ignores rate cuts and rally continues after slight drift of 2.7%

February 2, 2000, Fed hikes rates  25 bps and total three times that year

The Rally actually peaked on January 14, 2000

Irrational Exuberance

In a speech on December 5, 1996, Federal Reserve Chairman Alan Greenspan uttered these now famous words "irrational exuberance."  The Maestro grappled with balancing inflation, employment and bubbles.  The Dow dipped 140 points over the next week before resuming its irrational rally.

The Challenge of Central Banking in a Democratic Society

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums implies higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

Oct 2002 - Oct 2007 Bull Market

After bottoming at 7,216, the market reversed getting help from an avalanche of rate cuts that actually began in 2001.  In fact, there was only one rate cut in 2002 and 2003.

In June 2004, the Fed finally raised rates 50 bps sending the stock market down 100 points immediately and a total of 621 points or 6.0%.

The first rate hike in 2005 came on February 2, and while there wasn't a violent reaction, the Dow drifted 526 points to 10070 or 5.0% by April 28.

The Fed hiked rates four times in 2006, and save for a dip in the spring, the market continued to rally higher.

Fed Action

Rate Cuts

Stock Market Reaction

 

January 3, 2001 -50 bps to 6.00

The Fed cut rates six times in 2001

The Dow closed at 10,945 but was on its way to freefalling as the air came sucking out the Mother of all Bubbles (in our lifetime)

November 6, 2002  -50bps to 1.25

This move may have stoked a reversal  after the Dow bottomed at 7,216 on October 9, 2002

 

June 25, 2003 -25 bps to 1.00

By this time the market has a head of steam with the Dow closing this day at 9,109

 

Fed Action

Rate Hikes

Stock Market Reaction

 

June 30, 2004 +50bps

The Fed hikes rates five times this year

Day of hike Dow closed at 10,435 down 100 points next day, drifts to low 9,814 August 12- the low

In 2005, Fed hikes rates eight times

Market continues to rally as does the housing market- unemployment  goes to 4.9% at year end

 

In 2006, Fed hikes rates four times

Market rally continues, housing boom continues, unemployment rate at year end 4.4%

 

Rally peaks October 9, 2007, amid a mad scramble of interest rate cuts as history repeats itself with the Fed over-engineering and unable to save market from violent sell off.

Fed Action

Rate Cuts

Stock Market Reaction

 

September 18, 2007

Fed cuts 50 bps to 4.75

The Dow finishes session at 13,739

 

 

Fed cuts twice more in 2007 including October 31, 25 bps and December 11, 50 bps

By now the action from the Fed smacked of typical desperation and the Dow peaked on October 9  @ 14,164

Conclusion

There is a lot of fear-mongering out there from people with ulterior motives.  Most missed the rally, many dislike President Obama so much they think anything that makes him look good should be dismissed, and then there are a lot of cynics burned over and over.  The irony is President Obama's polices have held this market back, as it's not the domestic economy driving profits but global growth.  As for Fed influence, my hunch is that it’s 10 to 15% of the market's climb as professionals find equities are the only place to make money, but there is no hysteria and valuations are not irrational. There will come a time to be afraid, but be leery of missing money making opportunities waiting for the Fed to take away the punch bowl.

Dow Rallies

Rate Hike Reaction

Oct 1990 to Jan 2000

Oct 2002 to Oct 2007

Days

3,382

1,826

Gain

396%

94%

Reaction First Rate Hike

-6.0%

-7.2%

Number of Rate Hikes

17

10

Rally After First Rate Hike

71 Months

40 Months

Gain After First Rate Hike

223%

44%

Charles Payne
Wall Street Strategies


 

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