Re: Birchtree's account talk
"A rate cut helps stocks in several ways. By lowering market interest rates, it reduces the return on bonds and money-market accounts, making stocks look better in comparison. It makes it cheaper for consumers and businesses to borrow; this stimulates the economy and can lead to faster growth. If recession is threatened, rate cuts can help prevent or mitigate it. A rate cut also can fuel investor optimism.
The actual economic impact typically doesn't kick in for six to 12 months, however. That means that if a recession is beginning, the rate cuts may lessen its impact, but not prevent it. Heavy rate cuts also can fuel inflation and cause investment bubbles - and the nagging inflation concern was one reason the Fed was initially reluctant to cut rates this time. (I'm dreaming of an investment bubble with a Dow of 40,000).
Some analyst think that, whatever happens at first, stocks will be up within a year. Charles Reinhard, director of portfolio strategy at New York fund manager Neuberger Berman, studied the past 11 series of Fed rate cuts. He concluded that in all but the most recent one, 2001, stocks showed gains a year after the Fed started, with an average one-year increase of 16%. He considers 2001 an aberration because it followed a devastating stock bubble. He notes, however, that stocks at times suffered nasty declines before turning up. In four cases, stocks still were down five months after the rate cuts began.
Whether stocks rise after rate cuts depends on whether the economy is poised to rebound or poised to sink. Take your cue from what's going on in the economy - that will trump the Fed every time. Historical data can be a little misleading, because the Fed changed its approach to rate cuts starting around the mid-1980s. Instead of reacting to economic cycles, the Fed began trying to act pre-emptively, trying to cut rates in advance of actual recession. That didn't prevent recession or a stock bear market in 1990 or 2001, but it did work in 1995 and again in 1998 (when the problem was a series of financial shocks, rather than a recession risk).
This time, because the Fed felt inflationary pressures were under control, it decided to move in September, at a time when the economy still was growing strongly. That meant that, instead of cutting rates as the economy came out of recession and was poised to rebound, the Fed was fighting to hold back the forces of frozen credit markets."
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