As most know markets are forward looking, anticipating changes in the economy, government, and the Federal Reserve. As such, looking at how markets have reacted in the past to previous interest rate cycles and business cycles is warranted. I took data from the National Bureau of Economic Research (NBER) of the past business cycles since 1950 to see how the S&P 500 reacted and also the timing of the market and interest rate cycle peak in relation to the business cycle peaks.
Table 1. Data from NBER Business Cycle Dates
As seen from the data above of the last eight business cycles, the average lag between the Fed Funds rate peak and the economy's peak averaged less than 4 four months (3.75 months). The Fed Funds rate peaked before the business cycle with only two exceptions where the Fed continued raising rates after the business cycle had already peaked.
The S&P 500 peaked both before the Fed Rate peak and the business cycle peak, peaking on average 7.5 months prior to the business cycle peak and peaking roughly 3.5 months prior to the Fed Rate peak. Graphs of the S&P 500 and the Fed Funds Effective rate (the daily effective federal funds rate is a weighted average of rates on brokered trades) for the above business cycles are given below. Interest rate data was taken from the Federal Reserve Board.
Figure1.
Notes: S&P 500 peaked prior to rate peak and bottomed prior to rate bottom
Figure2.
Notes: S&P 500 peaked prior to rate peak and bottomed prior to rate bottom
Figure3.
Notes: S&P 500 peaked prior to rate peak and bottomed prior to rate bottom
Figure 4.
Notes: S&P 500 peaked prior to rate peak and bottomed prior to rate bottom
Figure5.
Notes: S&P 500 peaked prior to rate peak and bottomed prior to rate bottom
Figure 6.
Notes: S&P 500 peaked after rate peak and bottomed prior to rate bottom
Figure 7.
Notes: S&P 500 peaked prior to rate peak and bottomed prior to rate bottom
What do the above charts indicate? In all but one of the charts above, with the exception of Figure 6, the markets peaked before rates peaked and bottomed before rates bottomed, proving the markets are anticipatory. The markets began to sell off months before rates peaked! That being the case, CAUTION IS WARRANTED as we are nearing the end of rates right now.
The general consensus in the markets is that the Fed will likely stop at 5-5.25%. What if the markets are wrong? If they are the markets could be headed for a nasty correction. I believe the Fed is in a real tight spot right now. They don't want to overshoot as the housing market is clearly slowing and they don't want to undershoot as commodities are clearly rising (see charts below).
Figure 8.
Figure 9.
Source: Dismal Scientist
Table 2. Comparison of Market & Commodities Price Action since 2000 Market Peak
Source: Matt Davio, 'Then and Now', with modifications
Table 2 clearly shows a dramatic rise in commodity prices in energy, base metals, and agriculture while only the DJIA is above its prior market peak. With gold pushing above 0 an ounce, silver near decade highs, crude near an all-time high, the Fed definitely will be taking notice of commodity inflation and may push rates further than most are expecting. If this happens a correction in the markets is likely, and I might add, long overdue. The S&P 500 has not had a 10% or more correction in 779 trading days since it last saw a 10% advance (see chart below).
Figure 10.
Source: Ron Griess, https://www.thechartstore.com
The current S&P 500 advancement has been the second longest period since 1943 without having an opposite swing of 10% or more. Taking this into consideration, the length of the current bull market, and the possibility that the Fed will push rates higher than most think...CAUTION IS WARRANTED!
Bulls vs. Bears
In Peter Navarro and Matt Davio's recent FSO editorial, "So What Year Is This?", Mr. Navarro believes we are in the late stage expansion phase "sprinting towards the precipice--just like in 2000." Table 2 above was modified from Matt Davio's "Then and Now," in which he looks at the overall condition of the markets since March 31, 2000. Matt's commentary in reference to Table 2 is given below:
But let's step back and take a look at the overall markets going back to the bubble highs of March 31, 2000. Sometimes it's best to view the really big picture versus the daily bull vs. bear battles that we get jammed down our gullets from the mass media every day.What I would like to do is just provide you with some gross numbers from March 31, 2000 versus April 7, 2006 prices and let you take the static out and decide where we are with this market.Of the major indices, only the Dow is in positive territory since 2000--and that's only 30 stocks.As for the dollar, it has gotten positively squashed - down 15%. So your buck goes for far less than it did six years ago.Meanwhile, oil is inflated by the tune of 160% and Gold is right there, up 112%. Commodities have also all skyrocketed to new highs.The only good news here is that interest rates have been low. You can see how this has provided fat times for the Banking industry which was able via easy credit to loan to consumers at record paces, therefore driving up Real Estate.I will leave the conclusions to draw from these numbers in the readers' hands.My conclusion: CAUTION IS WARRANTED!
Today's Market
Stocks retreated in afternoon trading giving back most of their morning gains after comments from Donald Kohn, a member of the Federal Reserve Board, said the top priority of the Federal Reserve is to make sure that inflation stays well anchored. His remarks coupled with the 10-year Treasury breaking the 5% yield mark for the first time since June 2002 weighed on the markets.
Michael Sheldon, chief market strategist at Spence Clarke LLC, said that "When you combine oil prices near record highs along with bond yields above 5%, that provides a difficult cocktail for investors to handle. With bond yields having broken a downtrend going back to the late 1980s, that opens the door to higher yields over the next several weeks."
In sector news, an analyst upgrade on Vertex Pharmaceuticals (VRTX) helped raise drug and biotech stocks, with the Amex Pharmaceutical Index (DRG) closing at 322.15, up 0.19%, and the Amex Biotechnology Index (BTK) advancing 0.96%, closing at 685.13.
Energy stocks were mixed early on as West Texas Intermediate Crude oil was down slightly, falling 22 cents to .40 per barrel before reversing course and finishing up 70 cents to close at .32 per barrel, up 1% for the day and closing in on the per barrel mark. Henry Hub spot natural gas fell 16 cents to .62 per mBTU. The Amex Oil Index (XOI) was down 0.29% in early trading before closing on a positive note along with crude, up 0.55 points to 1107.63 with the Amex Natural Gas Index (XNG) also reversing course to finish marginally up, rising 0.08% to close at 401.90.
Telecoms were mixed as Verizon Communications (VZ) continued its slide after a report that the company may pay up B to buy out Vodafone's (VOD) stake in Verizon Wireless, falling 0.64% to close at 32.81. Ericsson (ERICY) inched higher today after its handset joint venture with Sony Corp. reported a tripling of profit on stronger sales of their higher-priced phones, rising 0.69% to close at 38.18.
In economic news, Retail sales rose 0.6% in March, stronger than expected while import prices fell 0.4% in March and export prices rose 0.2%. Jobless claims rose 12,000 to 313,000 for the week ended April 8th, slightly higher than expected. The University of Michigan's preliminary reading on April consumer sentiment rose slightly to 89.2 as expected with business inventories remaining unchanged in February.
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