History Says: Rising Interest Rates Rarely Sink Stocks

The news-reporting powers to be have determined that rising interest rates are the bull market’s worst enemy.

In fact, the looming threat of rising rates is as unwelcome as the dreaded QE taper used to be. But wait, QE ended many months ago, and stocks are still near their all-time high (see here for detailed analysis of QE effect on stocks).

Could rising interest rates be a moot point (just like the end of QE was)? As we will see in a moment, rising rates are not as scary as many believe.

But first off, how does the Federal Reserve raise interest rates and which interest rate is the one being ‘manipulated’?

What’s the ‘Interest Rate’?

When the Federal Reserve (or the media) talks about raising (or lowering) interest rates, it is talking about the federal funds rate.

The federal funds rate is the central interest rate in the U.S. financial system. It is the interest rate at which depository institutions trade balances held at the Federal Reserve with each other overnight.

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How Does the Fed ‘Manipulate’ the Interest Rate?

The Federal Reserve sets the target rate. The target rate is currently 0 – 0.25%. The Fed ‘manipulates’ this rate via government bond purchases (i.e. the Federal Reserve reduces liquidity and raises the federal funds rate by selling government bonds).

The actual rate is determined by trading between banks. The weighted average of bank transactions is considered the effective federal funds rate (currently 0.11%).

What Really Matters: How Do Interest Rates Affect Stocks

But what really matters is how the federal funds rate affects stocks.

Here’s what the data says:

The chart below plots the S&P 500 (NYSEArca: SPY) against the federal funds rate going back to 1954.

Periods of rising interest rates are highlighted in green.

More often than not, the S&P 500 moved higher (or didn’t decline significantly) when interest rates rose. The few exceptions are marked with a red box.

Most recently, the S&P 500 rallied when rates were buoyed starting in 2004 and 1998.

The green areas clearly show that rising rates are not bearish for stocks.

However, it needs to be pointed out that when the stock market rolled over in 2000 and 2007, the Federal Reserve had a lot of room to lower rates and stimulate growth.

That is not the case today. If this economic recovery does not stick, and stocks fall, the Federal Reserve won’t have much room to lower rates. It would take several rate hikes to build up a ‘cushion,’ that would allow the Fed to lower rates if the economy relapses.

Perhaps that’s why the Federal Reserve has been so hesitant to raise rates, and thereby spook the market.

Rather than focusing on rate hikes, I will continue to monitor the indicator that correctly foreshadowed the 1987, 2000 and 2007 market tops. It also ‘told’ us consistently since 2010 that this bull market is alive and healthy. Here’s what this indicator, which I dubbed ‘secret sauce’ is telling us right now. Is the S&P 500 Carving Out a Major Market Top?

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

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Smart Fed Fund Money Projects New S&P 500 Lows

The 30-day Federal Funds Rate (FFR) is the rate that banks charge each other for overnight loans to meet their reserve balance requirements. The FFR, in essence, acts as the base rate for all other U.S. interest rates.

With a couple of tweaks the stale FFR can be turned into a forward-looking indicator. Here are the tweaks:

  • We look at FFR sentiment provided by the commitment of traders (COT) report. We are mainly interested in the net positions of commercial traders (considered the ‘smart money’).
  • We shift the COT sentiment data forward by 4 weeks.

We used the FFR to spot onset of last year’s May rally (when everyone was looking for ‘sell in May and go away’). Fed Fund Rate Suggests S&P 500 Rally

The January 4 Profit Radar Report drew attention to the following:

Commercial traders slashed their bullish 30-day Federal Funds Rate (FFR) bets by 37,812 contracts, the largest drop since December 2012. The correlation doesn’t always work, but the biggest drop since December 2012 is noteworthy. The FFR warns of a correction.”

The chart below is an updated version of the one featured in the January 4 Profit Radar Report. It plots the S&P 500 (NYSEArca: SPY) against the net FFR position of commercial traders.

Last week’s COT report showed a solid uptick in commercial’s long positions, but 1) it remains to be seen if the trend continues up and 2) there appears to be more down side before any up tick.

The FFR harmonizes with most other indicators I follow. A more detailed S&P 500 forecast is available here: Short-term S&P 500 Forecast.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.