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Last night all three of the top US stock market barometers (the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite) closed out at fresh all-time highs. The last time this happened was in December 1999 when the “Dot Com” boom was in full swing and other global indices were also hitting new records.

We all know what happened next. Equities reversed sharply led lower by tech stocks which had been driven to excessive valuations. This was on a combination of general investor exuberance coupled with a ramp-up in IT expenditure as companies beefed up their systems to guard against the “Millennium Bug” as the world clicked into the 21st century.

Of course, it was a different world back then in so many ways. And one key difference was in headline interest rates. At the end of 1999 the Fed funds rate stood at 5.5%. Now it has a target range of 0.25-0.50%.

But there are also similarities. Back then US rates were on the rise. From November 1998 to June 1999 the key fed funds rate stood at 4.75%. Then the US central bank began to temper investors’ “irrational exuberance” (to quote Alan Greenspan, Fed chairman at the time) by pushing rates higher. From June 1999 to May 2000 the fed funds rate rose from 4.75% to 6.5% - now all the talk is about when the Federal Reserve will raise interest rates again following on from the 25 basis point hike last December.

PM Bulletin

Back in the last century, the initial pick-up in interest rates had little effect on investor risk appetite. Stock markets flew higher to make a succession of fresh record highs even as the Fed spent the last half of 1999 tightening monetary policy.

But this is another way that things are different now. Whatever individual Fed members might say, and just last week San Francisco Fed President John Williams said the Federal Reserve should raise interest rates further this year, but the truth is that they just don’t dare. Look what happened after the US central bank raised rates at the end of last year? Stock markets slumped. I’m not saying the rate hike was the sole reason for the sell-off, but it was certainly a major contributor.

Equities will remain in favour as investors search for yield and capital gains in a zero/negative interest rate environment. All that changes when the Fed tightens monetary policy. For now, no one really believes that the Fed will do anything before December. This is perfect for equity markets as long as the US economy shows signs of improvement. But if the economic data takes a turn for the worse, stocks could sell off – even without a rate hike.

David: At the end of 1999 the Fed funds rate stood at 5.5%. Now it has a target range of 0.25-0.50%.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin PM

Category: PM Bulletin


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