Wednesday, July 2, 2014

"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%












No comments: