Tuesday, January 22, 2008

Do Cuts = $ ????

As most of you know, I am an evidence-based enthusiast, especially when it comes to medicine. I have been offering a lot of commentary on the market, but have been using a lot of sentiment from other experts to help shape my opinions. I would be remiss if I did not apply some evidence-based principles to the market. Unfortunately, I don't have the time, intellect, or tools to do the analysis to answer the question that you must ALL be asking. The question is, "The Fed cut the fed funds rate today, what does that mean for the economy or stock market in the intermediate future?"

Thankfully, Chris Ciovacco has already tried to answer the question. Chris is the Chief Investment Officer for Ciovacco Capital Management, LLC. http://www.ciovaccocapital.com/sys-tmpl/hometwo/

I'll give you all the bottom line.

There have been 9 rate cutting cycles since 1970. But, Chris only includes data since the 80s in his analysis, since inflation rates were so high in the 70s. He has presented the data in 2 ways, and I will show you both.

First, the probability that the market will be higher after the rate cut (his analysis was run in September of 2007, so that is why the dates shown are from September):

As you can see, there is a 75% chance that the market will be higher about 3 months after the rate cut. The earlier time period after the cut is shaky at best.

In the next chart, he demonstrates what would happen to $100,000 invested in the S&P 500 for one year after the Fed rate cut.

Looks like 15% appreciation using data from 2001, and 25% appreciation for data excluding 2001. That would be great!!

Hang in there everybody.

Also, in breaking news, Thompson Finanical expects earnings to grow by 11.4% when not including financials for the 4th quarter reports (earnings down 19% if include financials in the forecast).

1 comment:

Will said...

Steve - it's about time someone took on this axiom of macroeconomics. I guess it has face-validity: the higher the interest rate, the more you're likely to squirrel your money away - but it's still good to see some empiric data. Perhaps now there's even some 'power of suggestion' effect where consumer behavior is influenced by what we're told we're supposed to do.

Next up: the inverse relationship between inflation and unemployment?