Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21
Why Tether USDT, Stable Scam Coins Could COLLAPSE the Crypto Markets - Black Swan 2021 - 6th Jun 21
Stock Market: 4 Tips for Investing in Gold - 6th Jun 21
Apple (AAPL) Summer Correction Stock Trend Analysis - 5th Jun 21
Stock Market Sentiment Speaks: I 'Believe' We Rally Into A June Swoon - 5th Jun 21
Stock Market Russell 2000 After Reaching A Trend Channel High Flags Out - 5th Jun 21
Money Is Cheap, Own Gold - 5th Jun 21
Bitcoin and Ravencoin Cryptos CRASH Bear Market Buying Levels Price Targets - 4th Jun 21
Scan Computers - How to Test New Systems CPU, GPU and Hard Drive Stability With Free Software - 4th Jun 21
Hedge Funds Getting Bullish on Gold - 4th Jun 21
THERE ARE NO SOLUTIONS When the Media is the VIRUS - 4th Jun 21
Investors Who Blindly Trust the ‘Experts’ Will Get Left Behind - 4th Jun 21
US Stock Market Indexes Consolidate Into Flagging Pattern – Watch For Aggressive Trending Soon - 4th Jun 21
Microsoft (MSFT) Stock Trend Analysis - 3rd Jun 21
No More Market Bloodbath – Beyond Cryptos - 3rd Jun 21
Bank run, or run from the banks? - 3rd Jun 21
This Chart Shows When Gold Stocks Will Explode - 3rd Jun 21
The Meaning Behind Gold’s Triple Top - 2nd Jun 21
Stock Market Breakout Or Breakdown – What Does The Next Big Trend Look Like? - 2nd Jun 21
Biden’s Alternate Inflation Universe - 2nd Jun 21
What You Should Know Before Buying Car Insurance - 2nd Jun 21
Amazon (AMZN) Stock Summer Prime Day Discount Sale - 1st Jun 21
Gold Investor's Survival Guide - 1st Jun 21
Silver and Copper to Benefit from Global Electrification Push - 1st Jun 21
Will Gold Shine Under Bidenomics? - 1st Jun 21
Stock Market Buy the Dip, Again?! - 1st Jun 21
Stock Market Consolidation Ahead - 1st Jun 21
Stock Market Summer Correction Review, Crypto CRASH, Bitcoin Bear Market Initial Targets - 31st May 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Lower Interest Rates and the Relative Performance of Investments - Part 3 of 4

InvestorEducation / Learning to Invest Oct 22, 2007 - 01:02 AM GMT

By: Chris_Ciovacco

InvestorEducation

Best Financial Markets Analysis ArticleTo recap the main points :

  • Wall Street places a strong emphasis on the impact of the Fed’s actions on asset prices.
  • Lower interest rates help fuel inflation and hurt the U.S. dollar.
  • The current Fed is not afraid to make significant interest rate cuts and we can expect them to act swiftly in the face of any continued deterioration in housing, financial markets, or the general economy.

The Housing Market is Dragging Down the Economy – Time to Get Defensive, Right?

While there are many valid reasons to be concerned about the outlook for housing, asset markets, and the U.S. economy, we have to balance our concerns with the possible Fed reaction to any further weakness, which would most likely be additional interest rate cuts. You may think this is a good time to be ultra conservative as an investor, but history and the Fed’s track record are cause for striking a proper risk-reward balance based on what really matters in the long run, which is the preservation of purchasing power.

The assets to avoid or underweight in an inflationary environment are the more conservative fixed investment options such as money markets, CDs, and bonds (debt).

When you hold a fixed investment, you really do not own anything tangible; you have simply made a loan to another party which agrees to repay you, usually at a fixed rate. In a simple example, if annual price inflation is running at 10% per year, which was not uncommon in the 1970’s, and you are earning 5% in CDs, your purchasing power is actually declining by 5% per year. It is unfortunate, but the current state of the economic landscape and monetary policy penalizes both prudent savers and conservative investors via the destruction of their hard-earned purchasing power. Endless credit creation forces all investors to take on more risk if they hope to outrun the Fed’s money printers.

A Prudent, Diversified, and Balanced Approach is Needed

My last update, Stock Market Behavior Following Fed Rate Cuts , examined three previous Fed rate-reduction cycles which occurred in similar economic environments to the one we have today. The results may have concerned some clients and loyal readers since it appeared to have a bullish bias. I am in no way considering or advocating any investor become overly aggressive with their allocation to stocks (especially U.S. stocks) given the current set of economic uncertainties.

The analysis was done to simply gain some insight into the risk appetite of investors in the year following the first rate cut in a new Fed cycle. The results mesh well with my comments above in that investors did invest in stocks (a risk asset) following the first cut, at least in part to hedge against inflation. A significant part of successful investing is understanding how others most likely will react to current and expected market conditions. The cold, hard facts are the market does not care what we think as individuals.

We can benefit from understanding how others will most likely react to the current set of circumstances given how they have reacted to similar circumstances in the past.

Since there are an infinite number of variables which affect the relative performance of various investments, it is helpful to attempt to quantify the relative importance of some of the major variables such as inflation, the strength of the U.S. dollar vs. other currencies, GDP, unemployment, housing, interest rates (Fed Funds), and recent stock market performance. Our last update made a case the rate cutting cycles which began in July 1986, July 1995, September 1998, and January 2001, represented the best historical comparisons to the present day. In this update, I’ll expand on the concept of similarity to past events and include the performance of multiple asset classes vs. just exploring the performance of the S&P 500 after the first rate cut. Since I have previously collected daily historical data for multiple assets classes going back to January 1, 1995, I eliminated the rate cutting cycle which began in July 1986.

Determining How to Weight Different Factors and Different Historical Periods

With respect and understanding of the much warranted fear of further deterioration in the value of the U.S. dollar (a crash is called for by some), I decided to explore the relative importance of the U.S. dollar to stock prices vs. other major economic factors. The correlation between various economic factors and stock prices during the period 1995-2006 is shown in Table 1. The respective correlation to stock prices is relevant since stocks influence the risk appetite for all asset classes. The relative importance shown in the last column of Table 1 simply takes the absolute value of each correlation and scales them all to 100%.

Based on historical data from 1995-2006, GDP (or the strength of the economy) has been the most important factor influencing stock prices. The strength of the U.S. dollar was the least important. That finding may surprise many who have well founded concerns about the dollar’s possible impact on asset prices. I think there are two logical explanations for the dollar’s seemingly low relative importance. As mentioned above, monetary inflation or the expansion of the money supply is a global phenomenon.

This in no way diminishes the importance of protecting against a falling dollar.

If anything, it reinforces the importance since most major currencies, albeit at different rates, are being debased. Said another way, you may be able to lower the pace of loss of purchasing power by owning assets denominated in other currencies, but that alone may not protect you. The best protection on a global basis is via the ownership of tangible assets. It is not a stretch to say the real currencies in our world are tangibles like gold and crude oil since they are traded and priced globally based on supply and demand. Unlike paper or electronic money, it is also difficult in the short-to-intermediate term to vastly increase the supply of gold or crude oil.

The dollar’s possible negative impact on all U.S. asset prices, including stocks and bonds, would become much more relevant in the event of a disorderly decline vs. other currencies. Up to this point, the dollar has been hit hard, but has declined at a less than crisis-headline rate. The recent drop below 80 (see chart below) was significant and may signal a shift in global investors’ desire to hold dollars or more importantly dollar denominated assets (U.S. stocks, bonds, real estate). The chart is courtesy of www.stockcharts.com.

Next, we will take a look at how similar today’s economic landscape is to the previous periods of Fed rates cuts based on the economic factors shown in Tables 2-A and 2-B. To do this, I simply looked at the variance between the values of each economic factor today vs. past values. As an example, the published unemployment rate on September 18, 2007 (the day the Fed cut rates) was 4.60%. The published unemployment rate on July 6, 1995 (the day the Fed first cut rates in that cycle) was 5.30%. The variance between the two numbers is 15.21% (5.30% is 15.21% higher than 4.60%). Scaling all the variances to add to 100% produces a relative similarity between unemployment in 1995, 1998, 2001 and 2007. The economic data from each period of rate cuts is shown in Table 2-A and 2-B. The results of the similarity calculations are shown in Table 3.

Based on the economic factors in Tables 2-A and 2-B (unemployment, the prior year performance of homebuilders’ stocks, the prior year performance of the S&P 500, the Fed Funds rate prior to the firstcut, the published annual inflation rate, the value of the trade-weighted U.S. dollar index, the prior year percent change in the trade-weighted U.S. dollar index, and GDP figures for the four quarters preceding the first Fed rate cut) , the economic conditions in September 2007 are most similar to those in July of 1995, closely followed by those in September 1998.

On a relative basis, January of 2001 is not nearly as similar to today vs. 1995 and 1998. Said another way, based on the economic factors listed above, there is a 42.75% chance the next year will look most like the period from July 1995 to July of 1996, there is a 40.70% chance the next year will look most like the period from September 1998 to September of 1999, and there is a 16.54% chance that next year will look similar to the period from January 2001 to January 2002.

Go Back to PART II

Chris Ciovacco
Ciovacco Capital Management

Copyright (C) 2007 Ciovacco Capital Management, LLC All Rights Reserved.

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. As a registered investment advisor, CCM helps individual investors, large & small; achieve improved investment results via independent research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions. When looking at money managers in Atlanta, take a hard look at CCM.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS.

Chris Ciovacco Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in