Posted on 11/13/2002 12:18:52 PM PST by Gunslingr3
“Don’t fight the Fed”! Those were the words we heard over and over again on commercials, which were promoting a well-known market strategist who was a frequent guest on the TV show, Wall Street Week. This was one of his famous rules on trading the stock market. This mantra became so popular that virtually everyone we talked to before the last couple of years believed that all you had to do was buy stocks when the Fed was lowering rates. It not only seemed to make sense, but also had history on its side. Every time the Fed lowered rates over a sustained period of time the stock market was always up significantly 6-12 months after the first reduction. The only exception was in the Great Depression of the early 1930’s. This is the second exception.
We must have seemed to be “out of our minds” when we posted the comment “Is Greenspan Superman?” on 12/28/00 which just happened to be exactly one week before the Fed’s first rate cut on January 3, 2001. This is what we said: “We believe we have already entered a recession that started in the fourth quarter. Since it has taken 550 basis points on average to pull the US economy out of recessions since World War II, we sure don't believe that (after the largest speculative bubble in US history) it will be easy to turn around this economy. Remember we are starting from a discount rate of 6% and a Fed Funds rate of 6.5% presently. To put things in perspective, the discount rate was 6% in 1929 and after numerous easings the discount rate was at 1.5% in 1931. Treasury Bills yielded 5% in 1929 and wound up at .5% in 1931. In fact Treasury Bills averaged less than .5% for the 15 years following 1931. In spite of all the interest rate reductions Industrial Production declined 52% between 1929 and 1933 and another 29% in 1937-38. The simple formula of monetary easing does not always work and you don't have to go back 70 years to prove the case. The Japanese experienced an even more powerful example of "pushing on a string" (making it easier to spend money, but consumers and businesses won't spend) starting at the very beginning of 1990. The credit bubble is worse in the consumer and corporate area than ever before and the valuation extremes make every other major top in the market look tame. This is why the Fed will have a much more difficult time turning around this economy and the stock market in which the economy has never been more dependent.” We also posted a cartoon showing the impotence of the Fed, which we will post again today.
The most amazing thing to us is the fact that, even after the tremendous bear market that we are now in, we don’t seem to be able to learn from the past. Investors got excited each time the Fed lowered rates in 2001, but each of the 11 rate reductions turned out to be disappointing. In fact, one of the surprise reductions occurred when we appeared on CNBC on April 18th 2001 and while the market was up 500 points we stated that “this rate reduction will be just like the previous reductions and not have a continued positive effect on the market. (This interview is at the bottom of Comstock in the News). The Fed has waited almost a year since the last reduction and investors seem to have forgotten about how futile the reductions were in 2001. The S&P 500 rose to a new rally high of 925.66 on November 6th and that was potentially a new lower rally high than each of the prior counter-trend rallies this year. The first peaked at 1174 in March, then 1107 in May, 965 in August, and the latest at 925. Investors were quick learners when it came to not fighting the Fed. They seemed to have slowed down.
This was advice, and good advice, given by Martin Zweig for the 60s, 70s, 80s and early 90s. The advice appears to apply only within the typical federal funds range (e.g., 2%-7%).
One of the above copied posters (I can't remember which) has correctly pointed out that the funds rate fails to be a good indicator outside this "normal" range. It may even have the opposite effect in that it signals desparate measures are being taken.
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