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And in today’s essay, I’m revealing a surprising market correlation…
Today, I’m going to dispel one of the biggest myths around the stock market using just one chart.
But there’s a catch…
I’m not going to show you what the chart is tracking until we’ve had a chance to discuss it together.
Here’s a hint… the chart is going to have two data plots. The blue line represents the S&P 500, while the red line will remain a mystery.
Let’s take a look at the chart below…
Before I give away the game, let’s look at the relationship between the S&P 500 and the red line.
Sometimes, the red line and the S&P 500 move in the same direction together. Other times – like since the start of 2022 – the two lines move in opposite directions.
Here’s a closer look at the correlation between these two lines from 2009 to now…
Between 2009 and 2016, the S&P 500 gradually climbed higher while the red line mostly stayed flat.
Then, between 2016 and 2020, both the red line and the S&P 500 climbed higher together.
But between 2020 and 2022, the correlation weakened again. Stocks went higher once more while the red line plummeted.
Finally, in 2022, the negative correlation between the red line and the S&P 500 continued. This means that as the red line moves higher, the S&P 500 moves lower.
Over the last 14 years or so, there have been times when the S&P 500 and the mysterious red line are highly correlated, negatively correlated, and not correlated at all.
So, what is this red line and what is it tracking?
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This might be surprising…
But the red line represents the federal funds effective rate. In other words, the red line plots interest rates set by the Fed.
This chart is relevant now more than ever, because it shows the market’s expectation toward the Fed.
The market believes that if the Fed pivots and stops raising interest rates, then investors will buy back in.
But I don’t know if that will come true.
The data over the last 14 years clearly shows stocks and interest rates can move in the same direction together.
And if I were to go further back in time, then there would be plenty of other examples to back this up.
For example, between 2000 and 2002, the Nasdaq and interest rates fell together. But from 2003 to 2007, the Dow Jones Industrial Average and interest rates rose together.
Of course, there have been times when stocks went up while interest rates have fallen, and vice versa.
From 1984 to 1987, major stock market indexes practically doubled while interest rates fell by half. And from 1973 to 1974, the stock market got cut in half as interest rates doubled.
The bottom line is that the relationship between interest rates and the stock market is not as clear-cut as most people think.
We’ll have to wait and see whether the correlation between stocks and rates will continue to be negative… or if we’ll see another period when they move in the same direction.
If the latter happens, at least now you won’t be surprised when the market doesn’t follow conventional economic logic.
Happy trading,
Imre Gams
Analyst, Market Minute
Reader Mailbag
Which way do you think the correlation will go?
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