"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%

Market Returns in 2007, Changing Growth/Value, US/Int'l, SmallCap/LargeCap

2007 Stock Market Returns
Returns from December 29, 2006 to December 28, 2007:

1. DIA: [US]: Dow Jones Industrial Average ETF: +9.05%
   
2. $NDX: [US]: Nasdaq 100 Index: +19.93%
   
3. $COMPQ: [US]: Nasdaq Index: +10.73%
   
4. SPY: [US]: S&P 500 ETF (Large Cap): +5.06%
   
5. MDY: [US]: Midcap 400 ETF (Mid Cap): +8.04%
   
6. IWM: [US]: Russell 2000 ETF (Small Cap): -1.91%
   
7. EFA: [Int'l]: Developed International Market ETF: +10.64%
   
8. EEM: [Int'l]: Emerging International Market ETF: +34.96%
   
9. IVE: [US]: S&P 500 Value ETF: +0.17%
   
10. IVW: [US]: S&P 500 Growth ETF: +8.55%
    
11. IJJ: [US]: Midcap 400 Value ETF: +0.96%
    
12. IJK: [US]: Midcap 400 Growth ETF: +13.15%
    
13. IWN: [US]: Russell 2000 Value ETF: -11.08%
    
14. IWO: [US]: Russell 2000 Growth ETF: +7.42%
    

Observation 1: 2007 International Returns Trounce US Domestic Returns

The Returns of International Markets, including those from the Developed World (mostly Western Europe, Japan, and Australia) and the Emerging Markets (including China, Brazil, Russia, Mexico, India, Taiwan, South Korea) are doing much better than the US markets. The Emerging Markets (EEM) have done much better than the Developed International Markets.

Observation 2: Outperformance of International Markets is Part of a Multi-Year Trend

The outperformance of International markets, especially Emerging markets, is part of a multi-year trend, where Globalization is a key trend.

1. 2007 US SPY (S&P 500 ETF) Return: +5.06%
   
2. 2006 US SPY (S&P 500 ETF) Return: +14.70%
   
3. 2005 US SPY (S&P 500 ETF) Return: +5.13%
   
4. 2004 US SPY (S&P 500 ETF) Return: +9.04%

1. 2007 Int'l EFA (Developed Int'l ETF) Return: +10.64%
   
2. 2006 Int'l EFA (Developed Int'l ETF) Return: +25.28%
   
3. 2005 Int'l EFA (Developed Int'l ETF) Return: +13.94%
   
4. 2004 Int'l EFA (Developed Int'l ETF) Return: +20.56%

1. 2007 Int'l EEM (Emerging Int'l ETF) Return: +34.96%
   
2. 2006 Int'l EEM (Emerging Int'l ETF) Return: +31.15%
   
3. 2005 Int'l EEM (Emerging Int'l ETF) Return: +34.19%
   
4. 2004 Int'l EEM (Emerging Int'l ETF) Return: +26.25%

Observation 3: 2007 Small Cap Returns lagged Midcap and Large Cap

Small Cap Returns, as represented by the IWM ETF, lagged midcap and large cap returns in 2007.

Observation 4: Small Cap Underperformance is a new trend, breaking multi-year trend

From April 11, 2003 to April 5, 2006:

1. S&P 500 (Large Cap) Return: +54.77%
   
2. Midcap 400 (Mid Cap) Return: +94.98%
   
3. Russell 2000 (Small Cap) Return: +113.11%

From April 7, 2006 to December 28, 2007:

1. S&P 500 (Large Cap) Return: +16.52%
   
2. Midcap 400 (Mid Cap) Return: +9.77%
   
3. Russell 2000 (Small Cap) Return: +2.99%

For many years, Small Cap stocks have outperformed Large Cap stocks. These trends tend to remain for many years, and we have recently seen the pendulum swing from favoring small cap stocks, to large cap stocks.

Observation 5: 2007: Growth Outperforms Value

In 2007, Growth outperforms Value through all US asset classes.

Observation 6: Growth Outperformance is a New Trend, Breaking Multi-year Trend

From July 28, 2000 to April 4, 2006:

1. S&P 500 Value ETF: +31.08%
   
2. S&P 500 Growth ETF: -24.2%
   
3. MidCap 400 Value ETF: +132.78%
   
4. MidCap 400 Growth ETF: +29.07%
   
5. Russell 2000 Value ETF: +140.68%
   
6. Russell 2000 Growth ETF: +7.29%

From April 7, 2006 to December 28, 2007:

1. S&P 500 Value ETF: +13.47%
   
2. S&P 500 Growth ETF: +17.63%
   
3. MidCap 400 Value ETF: +5.76%
   
4. MidCap 400 Growth ETF: 12.6%
   
5. Russell 2000 Value ETF: -2.13%
   
6. Russell 2000 Growth ETF: +7.4%

This makes sense. In the 1990s, Growth stocks prevailed and value lagged. From 2000 to sometime around 2006, Growth stocks suffered, and value stocks reigned supreme. Now that the value stock cycle has run its course, we are at the beginning of a multi-year growth stock run.

Observation 7: In 2007, the Large Cap Nasdaq Stocks outperformed

In 2007, the Nasdaq 100, 100 of the largest Nasdaq stocks (which is heavy in high tech stocks) outperformed the Nasdaq thanks to the performance of the larger capitalized stocks such as Apple (AAPL) and Google (GOOG).

Observation 8: The outperformance of Nasdaq stocks may be the start of a new trend.

From January 4, 1999 to July 21, 2000:

1. Nasdaq 100 Index: +110.78%
   
2. Nasdaq: +85.44%
   
3. S&P 500: +20.06%

From July 20, 2000 to December 19, 2006:

1. Nasdaq 100 Index: -55.32%
   
2. Nasdaq: -41.94%
   
3. S&P 500: +0.10%

From December 18, 2006 to December 28, 2007:

1. Nasdaq 100 Index: +17.65%
   
2. Nasdaq: +9.81%
   
3. S&P 500: +4.81%

During the different periods, we see the Nasdaq outperform the S&P 500, then underperform the S&P 500 for many years. Recently, we've seen it change, and the Nasdaq is starting to outperform the S&P 500.

Typically the Nasdaq 100 seems to lead the Nasdaq either up or down. During the last period starting December 18, 2006, we notice that the Nasdaq 100 Index is leading the Nasdaq up.

Prediction over next several years:

If we assume that style trends tend to be multi-year trends, then over the next few years, we can predict that:

1. Large Cap will outperform Small Cap Stocks (Early stages)
   
2. Growth Stocks will outperform Value Stocks (Early stages)
   
3. Nasdaq stocks and Nasdaq 100 stocks will Lead once again (Early Stages)
   
4. International Markets will continue to outperform US stocks (Early to Middle Stages)
   

Prediction Correct: S&P 500 bounces then re-tests lows.

Here is the Prediction of the S&P 500 Bounce and Re-Test of Lows on June 8, 2007:



Now here is the actual behavior of the market during this period:




The prediction looks to be correct. Right now, the market is re-testing the lows. It is finding support in the area between the previous lows and the 50 day moving average. We have to wait and see if the support area holds, or else we will get some variation of this ABC Correction Prediction.