Monday, December 16, 2013

Fed Funds Rate and S&P500 returns

Here is the flip side of the return to equities after a rise in the Fed Funds Rate.  This graph shows the monthly performance of the S&P 500 after the initial decrease in the Fed Funds Rate (implemented during an inverted yield curve that signals a coming recession).
During the period starting in 1989, investors avoided a bear market.  But, the next two episodes saw large declines in equities.  It looks, in any case, like we might be able to expect a period of several months in which to measure whether the apparent monetary easing due to falling rates is effective before committing to a hedging strategy or a speculative short position.
In fact, while this includes only three events, these events suggest that serial correlation in these events is significant, and that the market signal in the few months after the initial rate cut might indicate the continued movement of the index over the cycle.
There is an awful lot of pressure out there for a hawkish Fed stance, so when the next cycle comes, I'm afraid that rate cuts will be tepid, and returns will look more like 2000 & 2007 than like 1989. 

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