Financial Sense ~ "Trying to Measure the Fed's Measured Moves" by Ron Griess 05/19/2005

FSO Editorials

Trying to Measure the Fed's Measured Moves
by Ron Griess
Proprietor, The Chart Store
www.thechartstore.com
May 19, 2005

The following three charts might be called �Trying to Measure the Fed�s Measured Moves� Here is how we constructed the charts:

Each chart shows the trough to trough period of the last three business cycles, two completed cycles and the current cycle.
The Dow Jones Industrial Average is shown as a monthly bar re-based to 100 with the close of the beginning trough month to provide a direct comparison of the price action of each chart.
The monthly average Fed Funds Target Rate is shown as the orange line. Prior to the officially designated term �target rate� in July, 1990, we use our interpretation of the Open Market Committee actions compiled from data released by the Federal Reserve Bank of New York.
We consider the first trough month to be month �zero� and count each month thereafter.
We have labeled each month of important changes in the direction of the Fed Funds Target Rate and circled those dates with an orange circle. We show an orange directional arrow corresponding to the movement in the Target Rate.
On the monthly bar chart of the Dow, we have added teal circles for the inflection points of the Target Rate and a teal arrow showing the movement of the Dow for the time period.
A bright green arrow is used to exemplify the direction of the Dow if it went up after a rise in Target Rate was finished. A red arrow is used to exemplify the direction of the Dow if it went down after a rise in Target Rate was finished.

Alan Greenspan originally took office as Chairman and to fill an unexpired term as a member of the Federal Reserve Board on August 11, 1987. We will focus on four distinct moves in the Fed Funds Target Rate since he began his chairmanship.

Chart 1 Notes:

The first move we will examine begins with the month labeled Month 64.
The monthly average target rate in February, 1988 was 6.52%. In March, 1988 it was 6.53% and is labeled Month 64. The Target Rate peaks 12 months later in March, 1989 at 9.75% and is labeled Month 76.
Month end closes for the Dow in March, 1988 and March, 1989 were 1,988.26 and 2,293.62. While the target rate was going up, the Dow advanced 15.4%.
After the target rate peaked, the Dow continued to advance another 16 months until July, 1990 and closed that month at 2,905.20. The advance from the March, 1989 close through the July, 1990 close was 26.7%.
July, 1990 marked the PEAK of the business cycle.
We have also illustrated a cycle of the Target Rate rising (months 6-21-49) on this chart before Alan Greenspan assumed the chairmanship of the Fed. It shows a flat market while the Target rate was rising and a strong advance in the Dow afterwards.

Chart 2 Notes:

The second move we examine begins with the month labeled Month 35.
The monthly average target rate in January, 1994 was 3.00%. In February, 1994 it was 3.22% and is labeled Month 35. The Target Rate peaks 12 months later in February, 1995 at 6.00% and is labeled Month 47.
Month end closes for the Dow in February, 1994 and February, 1995 were 3,382.02 and 4,011.05. While the target rate was going up, the Dow advanced 4.7% albeit in mostly sideways action.
After the target rate peaked, the Dow continued to advance. The target rate declined until June, 1999 and the Dow closed that month at 10,409.14. The advance from the February, 1995 close through the June, 1999 close was 159.5%.
The business cycle expansion CONTINUED throughout the period.
The third move begins with the month labeled Month 99.
The monthly average target rate in May, 1999 was 4.75%. In June, 1999 it was 4.76% and is labeled Month 99. The Target Rate peaks 12 months later in June, 2000 at 6.50% and is labeled Month 111.
Month end closes for the Dow in June, 1999 and June, 2000 were 10,970.81 and 10,447.90, down 4.8% for the period. While the target rate was going up, the Dow made its all-time high in January of 2000 at 11,750.28.
The target rate remained at 6.50% into January of 2001 and then started down. The business cycle PEAK occurred in March of 2001, nine months after the peak in the Target Rate.
The Dow ultimately bottomed in October, 2002 at 7,197.49 down 38.8% from its peak.

Chart 3 Notes:

The fourth move begins with the month labeled Month 31.
The monthly average target rate in May, 2004 was 1.00%. In June, 2004 it was 1.01% and is labeled Month 31. The Target Rate is still rising and is currently at 3.00% in May, 2005.
The Dow closed at 10,435.48 at the end of June, 2004. The Dow closed on May 13, 2005 at 10,140.12, down 2.83% for the period.
June, 2005 will be 12 months from the beginning of the rise in the Target Rate.

Summary Notes:

We are in the fourth sustained rise of the Fed Funds Target Rate under Federal Reserve Board Chairman Alan Greenspan.
As outlined above, the first three each lasted 12 months.
Two of the three came towards the end of a business cycle expansion � one ended 16 months prior to the onset of a recession, the most recent ended 9 months prior to the peak of the business cycle expansion.
In three of the four cases, the Dow essentially moved sideways while the Target Rate was rising. The exception was the first rise from March, 1988 to March, 1989. That was also the first rise after 1987 stock market crash.
In two of the three prior cases, the Dow moved higher following the end of the period of rising rates. The 2000-2002 bear market in the Dow followed the completion of the most recent rise.