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CAPITAL IDEAS: Are interest rates high or low relative to history?

Despite the benefit to savers, the Fed cutting interest rates this year could frighten consumers and potentially increase the risk of a recession in 2025; in that case, I would put the odds of a recession at about 30 percent

Interest rates in the United States were much higher in the 1980s than they are today. It is also true that the nation’s Gross Domestic Product (GDP) grew well throughout that decade despite those higher rates. According to data from the Federal Reserve Bank of St. Louis, the real GDP’s average annual growth rate during that time was three percent. Here are the year-over-year GDP growth rates for each year of the 1980s:

1980: -0.3%
1981:  2.5%
1982: -1.8%
1983:  4.6%
1984:  7.2%
1985:  4.2%
1986:  3.5%
1987:  3.5%
1988:  4.2%
1989:  3.7%

The early 1980s saw a double-dip recession, but growth picked up in the mid-1980s, reaching a peak of 7.2 percent in 1984. The latter part of the decade saw more moderate but still solid growth.

Consider that, throughout the 1980s, the average rate on a 30-year fixed-rate mortgage was 12.7 percent, according to data from Freddie Mac (Axios Macro provided that data and much of the following). That rate compares to a 7.09 percent rate last week and a recent high of 7.79 percent in the fall of 2023.

Axios points out that the 7.79 percent mortgage rate was higher than it was in every single week since November 2000. Although Freddie Mac data only goes back to 1971, data on Treasury Bills tells us that mortgage rates were lower than today for many of the years before. The current three-month Treasury Bill rate is 5.25 percent. The Treasury Bill rate was lower than that at some point each year from at least 1928 (when the data began) through 1967.

The point Axios makes is that the very high interest rates of the 1980s were not the norm—that decade was an aberration. Today’s interest rates may not be high compared to that decade, but they are still very high compared to historical standards. Given the high levels of debt and asset prices, if the Federal Reserve holds interest rates higher for longer, it risks pushing the U.S. into a recession.

A recession would be a welcome event if your only goal were to curtail inflation. However, many investors have the goal of not losing money. A recession would be catastrophic to investment portfolios. According to data from Standard & Poor’s, the average decline of the S&P 500 through recessions since the 1920s has been around 32 percent.

I have gone on record saying that the Fed should not cut interest rates this year. Despite the benefit to savers, that could frighten consumers and potentially increase the risk of a recession in 2025; in that case, I would put the odds of a recession at about 30 percent (historically, there is roughly a 15 percent chance of a downturn in any given year).

Despite my belief that the Fed should not cut rates in 2024, I believe they will. They will do so because of social and political pressure. They will cut rates because it is a signal of their intended monetary path. Most importantly, they will do it because they will have some cover to do so as the annualized rate of three months of trailing inflation approaches 2.5 percent (closer to their target of two percent, even if not attained).

If I were forced to make a prediction, I would say that the Federal Reserve will cut rates once by one-quarter of one percentage point during their December 2024 meeting. Although interest rates are higher than they have been historically—sans the 1980s aberration—the stock market will celebrate that one-time easing monetary policy as a signal that a cutting campaign has begun.

What does an eight-day streak of up days mean for the stock market?

On Friday, May 10, 2024, the Dow Jones Industrial Average closed at 39,512, marking its eighth straight day of gains. Since then and up to today, some investors are worried that the Dow is overhyped, overbought, and ready to take a dive.

I don’t see that streak as a sign that stock prices have hit a wall.

Let’s cover the “overhyped” argument. As a contrarian, when investors are wildly bearish, it is often a good sign that it is time to buy. When everyone is buying, a contrarian is looking to sell.

Higher stock prices tend to make investors more optimistic about the future. Still, according to the American Association of Individual Investors sentiment survey, bullishness isn’t much higher than the survey’s historical average.

Chart courtesy of AAII.

I don’t yet see excessive optimism as a threat.

Full disclosure: I am invested in the Dow Jones Industrials, so I am happy about that impressive run. But eight up days in a row isn’t exactly an unprecedented streak. There were two other streaks as long or longer since last year. In December 2023, the Dow was up nine days in a row. And in July 2023, there was a 13-day winning streak, which tied its longest streak since at least 1953. Since 1953, there have been 52 eight-day streaks and 94 seven-day streaks.

Bespoke analyzed Dow returns after seven-day and eight-day stretches of up days. The three-, six-, and 12-month returns after those stretches were similar, whether seven or eight days. However, the Dow’s returns after those streaks were more significant than returns in all other periods.

Chart courtesy of Bespoke.

Since 1953, the Dow has averaged about an eight percent return over any 12-month period. After a seven- or eight-day streak, the index has returned about 10 percent.

It is counterintuitive that, after a long streak of up days, stock prices wouldn’t experience a reversion to the mean. However, as Bespoke points out, these streaks tend to occur during bull markets, which are, by definition, periods of above-average returns. Despite the possibility of any short-term pullback, I am holding onto my Dow Index exchange-traded funds.

Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at Adviser is not licensed to provide and does not provide legal, tax, or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.


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