Market Behavior after the Fed Finishes

Now that we have had a Fed meeting without a rate hike, what's next for the market?  Barry Ritholtz summarizes research from several sources.  Check out his helpful guide, and then see why you should ignore all of these studies.

Link: Market Behavior after the Fed Finishes.

We have discussed ad nauseum what has happened after the Fed finished their tightening cycle. It turns out to be a bit more complicated than either the Bulls or the Bears expect. 1980 seems to be a dividing line when it comes to Fed cycles. In the …

The studies summarized are quite excellent examples of the problems with Wall Street research.  Since everyone on the Street seems to accept uncritically this sort of research report, trading and investing billions from the conclusions, there could be a contrarian opportunity here.

To illustrate the problem, let's try to get an open mind by stepping away from the Fed context for a minute.  Suppose I asked the following question:

What happens to the stock market at the end of a U.S. military intervention?

With everyone hoping for an end to the situation in Iraq, this seems like a great question.  I hope that there will be a need for these resesarchers to take it up soon.  Let me predict what they will find:

Ned Davis research will look at the (hundreds) of interventions since 1929 and provide a compilation of what the market did six and twelve months later.  Why use every intervention?  Perhaps because they have data for every intervention.  Why use 1929?  Maybe that is where their stock data starts.  It is up to the consumer of their compilations to do the heavy lifting:  deciding what time period is correct and whether all of the examples included are relevant.

In my hypothesized post-intervention study, for example, someone might complain that the 1983 intervention in Grenada and the 1989 invasion of Panama should not be included.  Someone else might suggest that only the biggest wars should be counted.  In the Fed study, some might want to include only the largest series of rate hikes.  Or the ones that culminated with rates over 7%.  Or the ones after we had sophisticated computer modeling to aid in forecasts.  Or  -- well, you get the idea.

The result that you reach depends completely on what data you include.  A researcher looking at the data first, and only then making a hypothesis, can find a way to prove anything.

Biryini can do a composite of all of the wars, but which ones to use?  Comstock may only go back 53 years.  Don't they have as much data as Ned Davis?  Why 53?  David Rosenberg, free to choose both which events to study and how long after the event to look, will surely find some crisis following the wars.

(Does anyone else share my amazement that the end of Fed hikes caused the 1987 crash?  I was there and I have read some books on it.  Lots of causes suggested, but the end of Fed hikes??  And 2000?  I thought that had something to do with a Y2K bubble, or the Internet, or bad analysts, or a new paradigm or something.  Lots of possible causes, but the end of Fed hikes?)

Turning back to the military intervention illustration, when the research from this is all in, someone will point out that the interventions since the Reagan era have had positive results.  Barry will point out that it was all part of the biggest bull market ever.

It is an inherent problem in this type of market research.  There is not enough data for a statistical study.  Most sensible consumers of this research do not care about what happened after a Fed hike during the Hoover Administration, but those are the two biggest losers --by far-- in the Investech list published by Barry.  In pondering that list Barry questions the inclusion of two (of the three most recent) results because they were part of a secular bull market.  At the same time he thinks it is fine to include two 70-year old results from the middle of the Great Depression!!

It almost looks like, well, like cognitive bias..... 

The answer to the question about "After the Fed" cannot be done statistically from past Fed actions.  It all depends on how well they have done their job.

Comments

[Barry Ritholtz]

Speaking of cognitive bias:

The first factor I mentioned was the shift in Fed policy as a possible source of the changing market reaction:

"In October 1982, the Fed shifted its emphasis from money-supply measures and "nonborrowed reserves" to an explicit funds rate-targeting procedure. That is one possible explanation for the change in results after Fed tightening ends. (See: When Did the FOMC Begin Targeting the Federal Funds Rate?)"

But the reason we go back to the historical comparison is Mark Twain's quote: "History doesnt repeat, but it rhymes" --

Im trying to see if there are any rhymes . . .

[oldprof]

Barry -- always honored to have your comments. I probably did not explain this very well, but the idea is to get away from a potential cause where people already have an opinion to get them to be more open-minded when they look back at the initial question. You try to avoid cognitive bias. It is a pretty standard teaching method. I could have used baseball statistics or something, and almost did. I might do so in the book version of this, if the Iraq conflict has already been settled.

For what it is worth, I respectfully disagree with your assertion about wars and the market. When you get around to checking the data -- and we are all confident that you will :) -- I think you will change your mind.

[Barry Ritholtz]

There is a causation and correlation issue with Fed activity -- interest rates and their impact are clearly relevant to the economy and corporate profits --

where as military actions are far more removed . . .