On January 25, Ben Bernanke spoke no surprises: The Fed's interest rate policy will be unchanged for another two years.
Question: What does this mean for the stock market through 2014?
Let me show you how quickly you can get lost if you try to answer this question using "fundamental" analysis.
Bullish answer: Low interest rates (and they are effectively at zero) are bullish for stocks, because borrowing costs for businesses are low. Companies borrow, revenues grow, stock prices rise -- simple.
Bearish answer: No, low interest rates are bearish for stocks, because, obviously, the Fed thinks the U.S. economy is too fragile to survive a rate hike. Weak economy = weak stock market -- simple.
Helpful, isn't it?
Now allow me to show you how different the answer looks when you view the question through the lens of technical analysis -- specifically, Elliott wave analysis, which is all about chart patterns.
In his March 2010 Elliott Wave Theorist, EWI president Robert Prechter used this chart to dispel the myth that low interest rates are bullish for stocks. (Prechter showed other examples too, but this one is very recent and vivid.)
As you can see, in 2007-2009 the Fed lowered the federal funds rate from near 5% to near 0%. And what did stocks do? They fell right along the falling rates.
OK, what about the bearish claim above -- that the weak U.S. economy, as reflected in the Fed's fear of higher interest rates, will dampen the stock market going forward?
Let's look again to the 2007-2009 period. The GDP growth in 2006-2007 was strong: 4.92%. The unemployment rate was low: 4.6%. Corporate earnings were booming. The real estate crash had barely begun. "Goldilocks economy" was a popular term at the time. And what did stocks do? The DJIA peaked above 14,000 in October 2007 and, despite the strong "fundamentals," went on its biggest losing streak in 70+ years, dropping 54% and ushering in "the Great Recession."
Now fast forward to March 2009. The Dow had crashed below 6,500; unemployment had more than doubled; a desperate Fed dropped interest rates nearly to 0%; foreclosures; bailouts; consumer confidence at an all-time low; general state of near-panic. And what did stocks do? The Dow bottomed out on March 6, 2009, and, despite the weak "fundamentals," staged its biggest rally in almost 80 years.
From these two examples, you'd have to agree that, paradoxically, "good economy" prompted the 2007 crash, while "bad economy" produced the 2009 rally. But here's an explanation that actually makes sense:
Broad market trends are not created by the news or economic conditions -- social mood is what creates them. Social mood doesn't depend on what Ben Bernanke had for breakfast -- it changes for endogenous reasons, and those changes follow the Elliott wave model.
So, how do you answer the question, "What do 0% interest rates through 2014 mean for the stock market?"
Start with the understanding just where in larger Elliott wave pattern the U.S. stock market finds itself right now. Read Prechter's new, January 2012 Elliott Wave Theorist -- it's an excellent place for you to start.
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