Investors would have to be stupid to ignore the Federal Reserve’s history of causing pain.
But that is exactly what momentum investors are doing now. History repeats itself, but human nature being what it is, many investors do not learn.
Let us explore, starting with a chart that spans 64 years. Please click here for an annotated chart of the federal funds rate. Please notice the following from the chart:
• The chart shows nine instances of recession.
• The chart shows that all instances of recession occurred when the Fed was either raising interest rates or had raised interest rates.
• The chart shows that, since 2009, interest rates have been extraordinarily low. The Fed has kept interest rates artificially low. Of course, you already know that the bull market in stocks started in 2009, coinciding with artificially low interest rates.
• The chart shows that interest rates are now rising but are still not near the historic average.
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The stock market and recessions
Historically the stock market starts weakening six to nine months before a recession starts. Recessions cause bear markets in stocks. When a bear market starts, it is difficult to know how much lower stocks can go. In the Great Recession of 2008, many investors lost half of their money.
For this reason it is extremely important for investors to keep a close eye on the prospects of a recession and the Fed’s policy. The Fed is prone to repeat its historical mistakes and cause investors significant pain.
The next recession
Recessions are extremely difficult to call in advance. Of some help are leading economic indicators. Examples of leading economic indicators are building permits and initial weekly unemployment claims. However, relying only on leading economic indicators does not work well. Investors ought to look at more comprehensive models such as ZYX Global Multi Asset Allocation Model. One of the problems many models face is that they work in some market conditions but not in others. The ZYX Global Multi Asset Allocation Model overcomes this difficulty by being an adaptive model, i.e., it changes automatically with market conditions. The model has inputs in 10 categories.
The model successfully predicted the great recession of 2008. The Arora Report subscribers went into mostly cash in 2007 and then started adding inverse ETFs as well as shorting the market for accounts that could short. The model turned bullish in March of 2009 when the Dow Jones Industrial Average
and the S&P 500 Index
were trading near their lows before the start of the current bull market.
There is good news. Right now the ZYX Global Multi Asset Allocation Model does not see a recession over the next year. However, this assumes that the Fed will slow the pace of raising rates. Historically, the Fed has not stopped raising rates when it should have. For this reason, investors need to stay alert — and stay bullish — but not overly aggressive. The Arora Report provides its subscribers with exact cash levels, hedges and positions to hold as well as what and when to sell.
In addition to keeping an eye on the Fed, money flows are an important tool that can give investors an edge. When money flows are positive, the market tends to go up. When money flows persistently turn negative, it is a cautionary signal. To see money flows in 11 popular tech stocks, please see “Money flows in 11 popular tech stocks suggest a contrarian signal is coming up.”
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.