How can I use this information?
The Federal Reserve has influence over but not control of the stock market. Stocks have averaged far better
performance during declining interest rate environments. But there have been exceptions to that tendency. The
record during 2000 - 2006 is one such exception. The million dollar question is this: Will stocks exhibit the inverse
relationship with interest rates that has been most typical since the Federal Reserve was established in 1913 or...
will stocks move directly with interest rates as they have since 2000?
The Fed's 8/17/07 reduction of the discount rate should be considered a positive sign, but it's no reason to "bet the
farm." The point is... never invest as if you know where the stock market is going. Don't allow positive signs to tempt
you to ignore proper diversification techniques. If a repeat of the 2001-2002 bear market would inflict a mortal
wound to your financial condition, you should lighten up on stocks.
SignalTrend's unemotional computer timing system is currently bullish, but it may change its buy / sell signal in the
near future. If that happens, SignalTrend will notify you by email. Remember, SignalTrend's stock market timing
system was backtested 100 years with excellent results!
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Source of interest rate data: St. Louis Federal Reserve
|Can the Fed Heal the Stock Market?
Proprietary Graphs, Tables and Analyses - All Rights Reserved
● On 8/17/07 the Federal Reserve lowered the discount rate to 5.75%.
● Declining interest rates have typically been better for stocks.
● Recent years have proven to be an exception to the typical stock/interest rate relationship.
● Fed funds rate is just one of many influences on the stock market.
The media has succumbed to Fed Focus... as if the direction of the stock market is determined primarily by the
direction of interest rates. It's true that declining interest rates have traditionally been more favorable to stocks.
Stocks and interest rates have generally had an inverse relationship. Falling interest rates have exerted a positive
influence on stocks. Lower average stock gains have been recorded while interest rates were rising. However,
recent history has been inconsistent with that historical record.
The discount rate is set by the Federal Reserve. It is the rate at which banks borrow money from a Federal Reserve
Bank. Changes in the discount rate are usually followed by similar changes in the rates of other key interest rates.
The fed funds rate is the interest rate at which a depository institution makes overnight loans of immediately
available funds (balances at the Federal Reserve) to another depository institution. Both rates are used by the
Federal Reserve Bank to influence the economy.
2000 2001 2002 2003 2004 2005 2006 2007
|DJIA vs. Federal Funds Rate
As early as December of 2000,
the Fed may have believed that
the economy was headed for
trouble. From 12/17/00 through
9/10/01, they lowered the fed
funds rate from 6.58 % to 3.5%.
After 9/11, rates continued to
decline. When the DJIA hit
bottom on 10/9/02 (B), the fed
funds rate was 1.73%. The
dramatic decline in interest rates
didn't prevent the 2001-2002
stock market decline (A-B).
Stocks and interest rates rose
together from mid 2004 to mid
2006 (C-D). Therefore, stocks
and interest rates departed from
their traditional relationship
during the 2000-2006 period.