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Monday, September 10, 2007

Is the Fed cutting interest rates really a good thing?

It seems like market participants have been wishing, hoping and praying that the Fed will cut interest rates for over a year now. Unfortunately, this may not be a good sign for the market, but a clear signal of worse things to come.

You see, the Fed cuts interest rates not because things are going great, but because they are seeing clear signals the economy is headed for rough waters.

In fact, the stock market has historically dropped around 40% during an average recession, so the Fed cutting interest rates may not be a signal market participants should be cheering about.

Two weeks ago, John Hussman had a brief section on this subject in his weekly Market Comment. He posted a couple of graphs showing how the S&P 500 did during Fed rates cuts that led up to the 2000-2001 and 1981-1982 recessions.

From 2000-2001, the Fed cut interest rates from 6.5% to 1.25%, and yet the S&P 500 tanked around 41.1% over that same period.

From 1981-1982, the Fed cut rates from 20% down to 11%, and yet the S&P 500 tanked around 21.5%.

The Fed cutting interest rates is not a cure-all that makes the market go up. The market does sometime do well because of rate cuts, but not every time.

So, if you've been betting on the Fed cutting interest rates in hopes of making a killing in the stock market, you may want to consider buying short term bonds instead--they will much more likely benefit.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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