Figure 13-2: Rising discount/fed funds rates: A harbinger of bear markets
Figure 8-4 showed that bear markets typically begin when the year-over-year rate of growth in consumer spending (black line) peaks and begins to fall. As shown in the shaded ovals, rising interest rates (green line, inverted, right scale), because they have been effective leading indicators of consumer-spending slowdowns, have usually been an effective indicator of approaching bear markets (vertical yellow bars). This did not turn out to be the case in 2004 and 2005, however, as heavy residential borrowing ignored rising Fed Funds Rates and continued to fuel consumer spending.
Conversely, the sharp reduction in the Fed Funds Rate in 2007 and 2008 did little to arrest the sharp slowdown in consumer-spending that ensued in 2008 and early 2009 and the major bear market that accompanied this traumatic economic downturn.
Current Comment: As noted in Figure 12-2, the Fed Funds Rate, at barely above “zero” % since year-end 2008, cannot go appreciably lower. Any longer-term movement in interest rates from this point can only be to the upside, an obvious risk that investors in stocks and bonds must monitor carefully.