"Don't Fight the Fed" is Wrong? What Is One Year Return After Rate Hikes or Rate Cuts?

A. There is a common Wall Street mantra: "Don't Fight The Fed".


When the Fed is pumping liquidity (reducing Fed Funds Rate, instituting Quantitative Easing (QE)), you should follow the market upwards.  If the Fed is taking away liquidity (raising Fed Funds Rate, and taking away Quantitative Easing), then be careful in the stock market.


This "Don't Fight the Fed" mantra seems to have worked very well since 2009, as the Fed cuts rates and institutes many Quantitative Easing programs, resulting in the stock market having a very good rally.


If the Fed starts to cut back on Quantitative Easing and raises rates, it is best to be careful in the market.


B. Is "Don't Fight the Fed" still Valid?


Since July 2000 (till July 2014), what is the one year future return of the S&P 500 every time the Fed has raised or cut the Fed Funds rate?   Does this validate "Don't Fight the Fed?"


The results are as follows:
1. The S&P 500 return one year after the Fed cuts rates (since July 2000) averages: -14.2%
2. The S&P 500 return one year after the Fed raises rates (since July 2000) averages: 10.1%


Based on the one year forward return after the Federal Reserve cuts or raises rates, the S&P 500 is up when the Fed raises rates, and the S&P 500 is down when the Fed cuts rates.


This is opposite of the mantra: "Don't Fight the Fed!"


C. There is a better correlation using another metric: The actual Fed Funds Rate


Since the "Don't Fight the Fed" doesn't seem to work, is there a better metric to determine whether the one year S&P 500 forward return would be positive or negative?


After researching the data, it isn't whether the Fed is cutting rates or raising rates, but the actual Fed Funds rate plays a big role in the S&P 500 forward return:


The results are as follows:


Since July 2000, the S&P 500 return one year after the Fed changes rates (up or down) or announces a QE program when:


1. Fed Funds Rate is less than or equal to 1%:  13.1%
2. Fed Funds Rate is between 1% and 2% (not including 1%): -1.9%
3. Fed Funds Rate is between 2% and 3% (not including 2%): -8.9%
4. Fed Funds Rate is between 3% and 4% (not including 3%): -7.1%
5. Fed Funds Rate is between 4% and 5% (not including 4%): -6.3%
6. Fed Funds Rate is between 5% and 6% (not including 5%): -2.1%


Based on this, the actual Fed Funds rate seems to have a better correlation with the S&P 500 one year forward return.   The best one year S&P 500 forward return is when the Fed Funds Rate is less than 2%.   Fed funds rate greater than 2% has a more negative one year forward S&P 500 return.




D. Data Points:

Date	Fed Funds Start	Fed Funds End	Fed Funds Diff	S&P	S&P Date + 1 year	S&P + 1 year	Return
7/3/2000		6.5		1469.54	7/3/2001	1234.45	-16.0%
1/2/2001	6.5	6	-0.5	1283.27	1/2/2002	1154.67	-10.0%
1/31/2001	6	5.5	-0.5	1373.73	1/31/2002	1130.2	-17.7%
3/19/2001	5.5	5	-0.5	1170.81	3/19/2002	1170.29	0.0%
4/17/2001	5	4.5	-0.5	1191.81	4/17/2002	1126.07	-5.5%
5/14/2001	4.5	4	-0.5	1248.92	5/14/2002	1097.28	-12.1%
6/26/2001	4	3.75	-0.25	1216.76	6/26/2002	973.53	-20.0%
8/20/2001	3.75	3.5	-0.25	1171.41	8/20/2002	937.43	-20.0%
9/14/2001	3.5	3	-0.5	1037.77	9/14/2002	889.81	-14.3%
10/1/2001	3	2.5	-0.5	1038.55	10/1/2002	847.91	-18.4%
11/5/2001	2.5	2	-0.5	1102.84	11/5/2002	915.39	-17.0%
12/10/2001	2	1.75	-0.25	1139.93	12/10/2002	904.45	-20.7%
11/5/2002	1.75	1.25	-0.5	915.39	11/5/2003	1051.81	14.9%
6/24/2003	1.25	1	-0.25	983.45	6/23/2004	1144.06	16.3%
6/29/2004	1	1.25	0.25	1136.2	6/29/2005	1199.85	5.6%
8/9/2004	1.25	1.5	0.25	1065.2	8/9/2005	1231.38	15.6%
9/17/2004	1.5	1.75	0.25	1122.2	9/17/2005	1237.91	10.3%
11/9/2004	1.75	2	0.25	1164.08	11/9/2005	1220.65	4.9%
12/13/2004	2	2.25	0.25	1198.68	12/13/2005	1267.43	5.7%
2/1/2005	2.25	2.5	0.25	1189.41	2/1/2006	1282.46	7.8%
3/21/2005	2.5	2.75	0.25	1183.78	3/21/2006	1297.48	9.6%
5/2/2005	2.75	3	0.25	1161.17	5/2/2006	1313.21	13.1%
6/29/2005	3	3.25	0.25	1199.85	6/29/2006	1272.87	6.1%
8/8/2005	3.25	3.5	0.25	1223.13	8/8/2006	1271.48	4.0%
9/19/2005	3.5	3.75	0.25	1231.02	9/19/2006	1317.64	7.0%
10/31/2005	3.75	4	0.25	1207.01	10/31/2006	1377.94	14.2%
12/12/2005	4	4.25	0.25	1260.43	12/12/2006	1411.56	12.0%
1/30/2006	4.25	4.5	0.25	1285.19	1/30/2007	1428.82	11.2%
3/27/2006	4.5	4.75	0.25	1301.61	3/27/2007	1428.61	9.8%
5/9/2006	4.75	5	0.25	1325.14	5/9/2007	1512.58	14.1%
6/28/2006	5	5.25	0.25	1240.12	6/28/2007	1505.71	21.4%
9/17/2007	5.25	4.75	-0.5	1476.65	9/16/2008	1213.6	-17.8%
10/30/2007	4.75	4.5	-0.25	1531.02	10/29/2008	930.09	-39.3%
12/10/2007	4.5	4.25	-0.25	1515.96	12/9/2008	888.67	-41.4%
1/18/2008	4.25	3.5	-0.75	1325.19	1/17/2009	850.12	-35.8%
1/29/2008	3.5	3	-0.5	1362.3	1/28/2009	874.09	-35.8%
3/17/2008	3	2.25	-0.75	1276.6	3/17/2009	778.12	-39.0%
4/29/2008	2.25	2	-0.25	1390.94	4/29/2009	873.64	-37.2%
10/7/2008	2	1.5	-0.5	996.23	10/7/2009	1057.58	6.2%
10/28/2008	1.5	1	-0.5	940.58	10/28/2009	1036.19	10.2%
11/25/2008	Start QE1	Start QE1	0	857.39	11/25/2009	1110.63	29.5%
12/15/2008	1	0.25	-0.75	868.57	12/15/2009	1107.93	27.6%
3/31/2010	End QE1	End QE1	0	1173.27	3/31/2011	1325.83	13.0%
11/3/2010	Start QE2	Start QE2	0	1197.96	11/3/2011	1261.15	5.3%
6/30/2011	End QE2	End QE2	0	1320.64	6/29/2012	1362.16	3.1%
9/13/2012	Start QE3	Start QE3	0	1687.99	9/13/2013	1687.99	0.0%

End of World Portfolio: Gold, Guns, and Spam: Outperforming

Some people say that the End of the World Portfolio consists of "Gold, Guns, and Spam".

To evaluate these, we will compare the S&P 500 compared to Gold (GLD), Guns (RGR: Sturm Ruger, maker of firearms), and Spam (HRL, Hormel, maker of Spam).

(Dividends not taken into consideration):

1. First Major Downturn: October 2007 to September 22, 2011:
   
   
   
   • S&P 500: -27.83%
     
   • GLD: +131.29%
     
   • HRL: +57.62%
     
   • RGR: +68.98%
     
   
   
   During this time period, the "End of the World Portfolio" trounced the US Market S&P 500 index.
   
   
2. Downturn Peak to Trough: October 29, 2007 to March 9, 2009:
   
   
   
   • S&P 500: -51.83%
     
   • GLD: +24.23%
     
   • HRL: -14.97%
     
   • RGR: -44.86%
     
   
   
   From Peak to Trough, 2007 to 2009, the End of World Portfolio outperformed the S&P 500. We do see that the more traditional defensive GLD and HRL did better in the downturn than RGR.
   
   
3. Recent Peak to Now: July 7, 2011 to September 22, 2011:
   
   
   
   • S&P 500: -16.63%
     
   • GLD: +13.34%
     
   • HRL: -10.01%
     
   • RGR: +23.2%
     
   
   
   

Hormel (HRL) has a forward PE 15.11, a Forward Yield of 1.80%, and a 5 year estimated growth rate of 9.50% for a PEG+Y ratio of: 1.3

Sturm Ruger (RGR) has a forward PE of 15, a Forward Yield of 1.90%, and an unknown 5 year estimated growth rate.

Stock Market S&P 500 in Upper Range of 60 Year Mainstream Price Channel

The S&P 500 (US Stock Market) has been going down for sometime, and the S&P 500 went down 6.7% on August 8, 2011, to 1119.46. From the long term view, where is this market headed?

If we look at the S&P 500 chart from 1950 to 2010 (We made this chart the middle of 2010), we see that the S&P 500 Stock Market is now solidly within the mainstream price channel between the years 1950 and 2010. The peaks in 2000 and 2008 can be considered part of an unsustainable "Bubble" period.



Based on the charts, the current price channel (2011) appears to be somewhere between 500 and 1300 on the S&P 500. Over the long term, the trend still is up, but over many years, the S&P 500 might trade within this mainstream price channel for many years.

Stock Market To Stagnate for Years

In June 2010, we blogged about the US Stock Market stagnating for around five years within a Secular Bear Market. We still hold that view.

Lower Highs, Lower Lows, Violent Rallies in a Secular Bear Market

Since 2008, we appear to be making lower highs (around 1500 in 2008, and around 1370 on the S&P 500 in 2011), and maybe we'll be making lower lows.

If we are in a Secular Bear Market, this does not mean we will be going straight down in a straight line. There will be many tradeable and violent snapback rallies when we least expect it, but these will be Bull Markets within a Secular Bear Market.

Scary Similarity: Charts 1929-1930, and 2008-2010; Big Drop or Crash Ahead?

There are scary similiarities if you look at the charts today (2008-2010) and the Charts (1929-1930) around the time of the Great Depression.

Here is the current chart from 2008 to 2010 of the S&P 500:



Here is the chart from 1929 to 1930 of the Dow Jones Industrial Average (DJIA)



Comparison Points

On each chart, there are labels. A label on one chart, should correspond (similarity) with the same label on the other chart.

1. 
   A: 2007: S&P 500 peak of around 1560
   A: Sept 1929: Dow Jones Average peak of around 380
   
   
2. B:2008: S&P 500 Drops from 1560 to 1270, -18% drop.
   B:1929: Dow Jones Average Drops from 380 to 325, -14% drop.
   
   
3. C:2008: S&P 500 Intermediate Peak from 1270 to 1440, +13%.
   C:1929: DJIA Intermediate Peak from 325 to 352, +8%.
   
   
4. D:2008: S&P 500 Crashes in short time period.
   D:1929: Dow Jones Average Crashes in short time period.
   
   
5. E:2008: S&P hits intermediate bottom of 741, a drop of 52% from peak of 1560.
   E:1929: Dow Jones Average hits intermediate bottom of 230, a drop of 39% from peak of 380.
   
   
6. F: 2008: S&P 500 Sharp Rebound from 741 to 944, a gain of 27%.
   F: 1929: Dow Jones Average Rebound from 230 to 271, a gain of 18%.
   
   
7. G: 2009: S&P 500 hits Bottom from 1560 to 666, a loss of 57.3%
   G: 1929: Dow Jones Average hits bottom from 380 to 198, a loss of 48%
   
   
8. H: 2009: S&P 500 Rebounds from bottom.
   H: 1929: Dow Jones Industrial Average Rebounds from Bottom.
   
   
9. I: 2009: S&P 500 Pulls back from Rebound.
   I: 1929: DJIA Pulls back from Rebound
   
   
10. J: 2010: S&P 500 Hits "Left Shoulder"
    J: 1930: DJIA Hits "Left Shoulder"
    
    
11. K: 2010: S&P 500 Hits "Head"
    K: 1930: DJIA Hits "Head"
    
    
12. L: 2010: S&P 500 Hits "Right Shoulder"
    L: 1930: DJIA Hits "Right Shoulder"
    
    
13. M: 2010: S&P 500 Hits "Rare Double Right Shoulder"
    M: 1930: DJIA Hits "Rare Double Right Shoulder"
    
    

Rare Double Right Shoulder 2010, and in 1930 Before More Drops

Another similarity involves a rare technical pattern, the Head and Shoulders Top with a Double Right Shoulder.

Two other writers including one from China Daily, and the other from CNBC have written about this.

2010: Double Right Shoulder in Head and Shoulder Pattern



1930: Double Right Shoulder in Head and Shoulder Pattern



Big and Long Drop Ahead?

If the Pattern holds, are we in for a Big and Long Drop Ahead?

In 1930, after the rare Double Right Shoulder in a Head and Shoulders Technical Pattern, the Dow Jones Industrial Average Continues to fall from 275 in 1930 to around 41, July 1932, a drop of 85%.




Of course, just because the charts are similar in both eras does not necessarily mean we will repeat history.

But it does make us think.

Today's S&P 500 Chart

U.S. S&P 500 Stock Market to Stagnate for Five Years in Secular Bear Market

The U.S. Stock Market, as represented by the S&P 500 Index, could stagnate for a long time period (such as five years).

Long Term S&P 500 Price Channel Since 1950



Since 1950, the S&P 500 Stock Market has been in a consistent price channel, until the year 1995, when the S&P 500 starts the runup at an unsustainable rate, until the peak in 2000. During the time period starting in 1995, the S&P 500 has gone above the long term Price Channel.

We are just starting to see the S&P 500 get back to the top of the normal long term price channel.

In the Reversion to the Mean Theory, this means that the S&P 500 will have to trade sideways for some time to remain consistently in the channel.

Based on the lines above, the S&P 500 should be trading around the level of 500 to 1200.

Five years from now, the S&P 500 could be trading from the 600 to 1500 level, to remain within the long term price channel.

We are in middle of 17 Year Secular Bear Market

Over the long term, the U.S. Stock Market Appears to be in Bull Markets or Bear Markets (Secular Bull Market and Secular Bear Market) for an average of 16 to 17 years.

One grouping consists of:

1. 1906-1921: Secular BEAR Market
   
2. 1922-1928: Secular BULL Market
   
3. 1929-1949: Secular BEAR Market
   
4. 1950-1965: Secular BULL Market
   
5. 1966-1982: Secular BEAR Market
   
6. 1983-1999: Secular BULL Market
   
7. 2000-????: Secular BEAR Market
   

This means that if the current Secular Bear Market started in 2000, and if the average Secular Market consists of 16 to 17 year time periods, then a new Secular Bull may start around the year 2016 or 2017, consistent with the Price Channel Behavior above.

More Details on Secular Bull and Bear Markets including Charts

Today's S&P 500 Chart

Is it Time to Get Back in the Market? (S&P 500)

After seeing the market go through a strong rally since early March 2009, and seeing today's action in the U.S. Markets, with the S&P 500 going up 2.58% to the $SPX Index level of 942.87, many people are asking whether it is time to get back in the stock market.

That question requires more details. What are you going to do with money? If the money is in a retirement account (the one with tax benefits), and you do not need the money for a decade or more, allocate your assets appropriately to reach that long term goal. This may include a large percentage in the stock asset class.

If the money is in a discretionary account, then there are even more options.

When do you need the money by? If you need the money in the short term (five years or less), you should consider putting the money in safer investments like money market accounts, or high yield online savings accounts.

Other considerations you may want to take are looking at your overall debt and pay off any bad debt such as high credit card balances. Paying off a credit card balance with 15% interest, means a 15% guaranteed risk free rate of return. This is a very good deal.

You may also want to consider other asset classes such as using that money for a down payment on housing, or starting a business.

A six month emergency fund in very low risk investments (such as high yield online savings accounts) is also a must, and adequate health insurance is a must.

After looking through all the above, and deciding that you do have long term discretionary money you can use to invest, then invest appropriately. You do not need to have an all-in, or all-out mentality. You can get in the market gradually,(20% now, 30% in a few months, 40% a year from now, 10% in cash), or increase cash positions gradually (if you are fully invested).

You would have saved around 32% in the S&P 500 if you had followed the following advice:

On February 26, 2008, this blog wrote and asked if you had too much risk in your Discretionary Portfolio. The S&P 500 at that time was around 1384. At the low, the S&P 500 reached 666, for a loss of 51.8%. Many people could have panicked at that time.

Even after the recent strong rally, the current S&P 500 is at 942, for a loss of around 32%.

Today's S&P 500 Stock Chart

Will S&P 500 Stock Market Rally or Continue Downtrend? Market is at Resistance.

The Market (as represented by the S&P 500) is at a decision point. Does the S&P 500 rally or continue the downtrend?




Currently, on Friday, Dec. 5, 2008, the S&P 500 is at 876, and is very near many resistance levels.

1. Horizontal Resistance: Around 900 to 916
   
2. 3 Month Downtrend Resistance: Around 879
   
3. 50 Day Moving Average Resistance: 936
   

If Stock Market breaks through these resistance areas with good volume, there's a good chance the rally continues to at least 1000 to 1040 on S&P 500.

Otherwise, the S&P 500 could continue its downtrend.

We can also pay attention to any big gap up at the open, followed by a high volume reversal to the downside to end the day down. This could mark a failed attempt to breach resistance.

Today's S&P 500 Chart

Stock Trading Ideas after Stock Market Drop Today

The S&P 500 went down 52.54 points today, to close at 806.58, a drop of 6.12%.

The S&P 500 broke below previous support of around 839 and 818.

We previously wrote what could happen if the S&P 500 breaks below 839, or even if the S&P 500 breaks 768.

This can be a very scary market, but for traders, this can be a great market. Traders like volatility. For many years, the US Stock Market had been trading at below average volatility, and it was just a matter of time before the stock market reversed itself and entered a high volatility phase. We are currently experiencing this high volatility.

Using SPY as Trading Vehicle

One trading vehicle is to go long (profit when stock goes up in price) or short (profit when stock goes down in price) the SPY, the S&P 500 ETF

The SPY attempts to mimic the S&P 500 index, but it is not a perfect match. In general, the SPY is currently at $81.50, and the S&P 500 ($SPX) is at 806.58, an approximate ratio of 1 to 10.

Using Inverse ETFs to Trade

Alternatively, you can use the inverse ETFs at Proshares.com.

Some of the products include:

1. SH: ETF that goes up 1x if the S&P 500 goes down 1x, and ETF that goes down 1x if the S&P 500 goes up 1x.
   
2. SDS: ETF that goes up 2x if the S&P 500 goes down 2x, and ETF that goes down 2x if the S&P 500 goes up 2x.
   

So rather than shorting the SPY, you can go long on the SH. Of course, the behavior and value of SH differ from SPY.

Trading Ideas After Stock Market Drop Today



The S&P 500 broke below previous support of 839 and 818 (on an intraday basis), and it appears as if we are in a breakdown and the SPY is trying to find a trading range.

We expect the upper band of the trading range to be previous support at around 839. It is known that what was once support now becomes resistance.

On the downside, it appears that 768 appears to be the next major bottom. This 768 bottom was reached October 10, 2002, 6 years ago, in a major bottom after the 2000-2002 Bear Market.

So if the S&P 500 ever reaches 768, we do not expect it to break through 768 right away. It should respect the 768 major support at least once.

So how can we formulate a possible trading plan?

A) First Trading Idea: Short SPY here

This plan refers to trade A) in the chart above.

We know upper resistance on SPY is around $83.50. And since the SPY recently broke down below this (ideally, with high volume), the short term trend appears to be down. In fact, it is possible that the SPY can shortly re-test resistance at $83.50 before continuing down.

The first trading idea is to short the SPY (or go long on the SH), around these levels.

Where is a possible bottom?

As we discussed earlier, $76.80 is a good target on the downside, and a single re-test of the October 10, 2002 lows should be in order. This is a major bottom.



We can cover the short near this area.

B) Second Trading Idea: Go Long SPY at $76.80

Since we expect at least a single re-test of the $76.80 levels, we can cover our previous short, and then go long SPY.

Where can we cover? We do not know how far the rally can last, but the resistance area of $81.80 to $83.90 area would be good bets.

C) Third Trading Idea: Short SPY after rally to $82

Once the rally runs out of steam, we can sell our previous SPY long position, and go short for the estimated re-test of the SPY low of $76.80.

We do not know whether the re-test at $76.80 will succeed or not, so it is best to cover the short around this area.

D) Fourth Trading Idea: If SPY breaks $76.80 to the downside, Short SPY!

If the SPY finally breaks the major support of $76.80 to the downside, it is time to short SPY because this would be a very bad scenario for the market, but an opportunity for you to profit.

Use Limit Orders, Stop Orders and Trailing Stops

This is a very fast moving market. If you cannot monitor the stocks every moment of the day, you can use limit orders, stop orders and trailing stops.

Today SPY is at $81.50. Let's say during this time, you put in a Limit Order to Buy at $76.80 (good for 60 days).

SPY starts going down (your order has not been executed at this time) but has not reached $76.80. Then several days from now, SPY reaches $76.80.

After purchasing SPY at $76.80, you then put in a Stop Order to Sell at $75. You expect SPY to bounce at $76.80 and go higher. If this happens, this is good, and you eventually take your profit.

But there are times when you are wrong. SPY could continue falling below $76.80 and when it hits $75, your SPY order to Sell will be active.

Is it possible that SPY reaches $75, hit your stop order to sell, then start climbing upwards again? Yes, this can happen. But it is good to remain disciplined, and stick to the rules.

You can also use Trailing Stops as a technique to limit losses, and to protect profits.

Let us Monitor the Situation

Of course, we should monitor the situation at each stage, and we should remain disciplined.

Today's SPY Chart

Today's S&P 500 Chart ($SPX)