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  • Writer's pictureMAC10

FOMC Preview

Below I will discuss the various factors that will weigh on the Fed decision this week.

First, we begin with the bull case:

"Ned Davis Research crunched the numbers and found that the Dow Jones Industrial Average jumps 15% on average in the first year after the Fed's first interest rate cut. But those gains are even stronger, at 24%, when the interest rate cuts are coupled with no recession in the economy"

Now the bear case:

"Fed-funds futures project five and as many as six cuts by December"

"Those rate-cut expectations ironically come while the stock market hovers near record highs and economic data continue to surprise to the upside"

The market’s pricing of up to six rate cuts implies economic distress, but the hope is for cuts without distress"

FR: Now for reality.

I looked at the Ned Davis bull case over the past four decades and found that there is no data to support the conclusion that rate cuts lead to higher stock prices over that timeframe. As the chart below shows, of the seven rate cutting episodes since the mid-'80s, four involved recessions and substantial drawdowns for stocks ranging from -20% (1990) to -55% (2008). Which leaves three times the Fed cut rates without recession, those times were 1987, 1995, and 1998. Of those three times, both 1987 and 1998 involved substantial stock market drawdowns prior to a rally. Which means that only a single data point (1995) supports the entire bullish thesis.

I would also point out that those who believe they can data mine 50+ year old statistics to predict the future are looking back at a time when debt levels in every part of the economy were much lower than what abides today. Which is what the lower pane clearly shows.

There's nothing quite as specious as data mining a single data point out of four decades in order to conclude that today's riskiest set-up in history is a buying opportunity.

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