Mid-Month Update: Fed Rate Cycle Review & Seasonal MACD Switching Strategy Update
By: Christopher Mistal
April 16, 2015
One headwind that exists for the market is the first Fed funds rate increase since June 2006. That 0.25% rate hike nudged the target rate to 5.25% and marked the last move in a major tightening cycle that began in June 2004. Including this cycle, there have been five major Fed cycles (up and down) since 1973. A major Fed cycle is defined as the overarching Federal Reserve policy with respect to the Fed funds rate. During major Fed tightening phases, tweaking of the rate towards an easing bias may have occurred, but the Federal Reserve returned to a tightening bias after the decrease. Major tightening phases appear in the table below. From the Fed Funds rate current value of 0-0.25%, it is clear there are really only two options available: the rate either goes up or remains roughly where it presently is even longer.

The period between tightening and easing periods, we dub Fed Transition Periods. This is the time period when the Fed was generally satisfied that rates were appropriate for economic conditions. During the tail end of Transition Periods, the Fed tends to shift wording in its statements in an attempt to ready Wall Street and prepare traders and investors for a rate change. We are currently in the tail end of a transition period with the Fed, rather timidly, attempting to signal when it will move to raise its target rate.

On average, the year prior to a major Fed Funds rate tightening cycle has been positive. However, one month after a major shift in policy towards tightening, the market has never been up, and averaged a loss of 2.7%. Three months later has been even more negative with an average loss of 4.8%. From six months to one year later, the averages are still negative, but a few modest gains have occurred. Also notable are that the last two times that tightening occurred with DJIA at or near all-time highs (1973 and 1999) the result was clearly negative.

Unlike these past five major rate hike cycles, today’s Fed will not be moving to fight inflation or cool economic growth. Inflation is running below their target and current U.S. GDP readings are not exactly red hot. What the Fed wants (or needs) to do is raise the target rate in order to have ammunition for the next time our economy stumbles. A well-telegraphed series of small rate increases could allow the Fed to “reload” while having only a minimal to modest impact on overall economic activity. It would be another spectacular tight rope act for the Fed to pull off, but their recent track record suggests it is something possible. One certainty that exists is the fact that the Fed will do no harm to the market or the economy, especially with the next presidential election cycle beginning already.

MACD Update

As of the close yesterday, both the faster moving MACD “Buy” and slower moving MACD “Sell” indicators (at bottom of following charts) applied to DJIA and S&P 500 were positive and trending higher. At the start of month, we anticipated April’s historical prowess for gains would eventually lift the market. Thus far, the market has lived up to expectations. 

[DJIA Daily Bar Chart]
[S&P 500 Daily Bar Chart]

Since April 2, DJIA and S&P 500 have moved decisively higher to reclaim their respective 50-day moving averages (solid magenta line). Stochastic and relative strength indicators have responded to the move with positive readings. About the only cause for concern is DJIA and S&P 500 have run into projected monthly resistance (red dashed line) and appear to be stalling. If they can break through resistance, they will likely move to new all-time highs again.

Continue to hold long positions associated with DJIA’s and S&P 500’s “Best Six Months.” We will continue to monitor the fundamental and technical outlook and issue our Seasonal MACD Sell signal when corresponding MACD Sell indicators applied to DJIA and S&P 500 both crossover to sell again.