Figure 13-2: Rising discount/fed funds rates: A harbinger of bear markets
Figure 8-4 showed that bear markets typically begin when the year-over-year rate of growth in consumer spending (black line) peaks and begins to fall. As shown in the shaded ovals, rising interest rates (green line, inverted, right scale), because they have been effective leading indicators of consumer-spending slowdowns, have usually been an effective indicator of approaching bear markets (vertical yellow bars). This did not turn out to be the case in 2004 and 2005, however, as heavy residential borrowing ignored rising Fed Funds Rates and continued to fuel consumer spending.
Conversely, periods of falling Fed Funds Rates, which have often begun during bear markets as the Fed has sought to stimulate demand, have almost always led to a recovery in consumer demand and the economy and stock market in general.
Current Comment: The current financial crisis notwithstanding, the sharp reversal in year-over-year changes in the Fed Funds Rate, from +200 basis points in mid 2007 to –400 basis points as of year-end 2008—a change that can be viewed in this chart in the context of American economic history—should not be ignored as potentially powerful stimulus to a recovery.
