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Thursday, August 10, 2006

The Post Fed Era- Some say it bodes well for the market & some think not. Whose right?

By Yaser Anwar, CSC of Equity Investment Ideas

In the last two weeks, i've read, speculated & wrote so much about Fed & interest rates, that i haven't done so in my three years of trading (hey i'm just 20!). So once again let me mention two sides of the market story & you can decide which side you're on.

The Bad Side

David Rosenberg, chief North American economist at Merrill Lynch, said in an interview that not only do markets display a lackluster performance, but often periods of crisis come shortly after the Fed goes on hold. "If we take a look in the past Fed pauses, they're the periods the arteries tend to harden and financial strains come in," he said.

The market plunged in October 1987, but the Federal Reserve was on hold by early September, he said. "It wasn't a case where the Fed was tightening on the 16th and the market crashed on the 19th," he said.

In 2000, strains started to show in the technology sector, but the Nasdaq Composite was virtually flat on the year in mid-2000. The Fed had ended its tightening campaign (six increases in 11 months) in May; the Nasdaq lost more than 40% in the second half of 2000.

The Fed tightened rates six times in 1994 and once more in early 1995, but the strains on the economy were felt in 1995. GDP growth was 1.1% and 0.7%, respectively, in the first two quarters of 1995, as investors felt the effects of a 30% rise in Treasury yields in the previous year."
The Good Side

Declining rates have historically been good for both bonds and stocks.

Bank of America recently analyzed 20 tightening cycles over the past 50 years and found that the Standard & Poor's 500-stock index rose consistently during the 12 months after the Fed stopped tightening.

For the period 1989-2006, the large-cap index rose an average of 17.4%, as opposed to 8.9% during the 12 months before the Fed stopped.
The Neutral Side

Whereas, WSJ talks about, when the Fed last paused in a rate-raising campaign, in the sense that it stopped increasing rates for one or more meetings, and then resumed.

Taking a look at every Fed rate decision since 1914, and guess what?

The Fed has never paused in a campaign to raise rates. Sometimes it has held rates constant for several meetings, but the next move has always been a cut.

Pauses aren't unheard of -- they occurred three times, in 1999, 1994 and 1988. But these all happened in periods of declining rates.

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