FED Rate Cut Studies

I came across an interesting headline regarding FED rate cut effects on the stock market. The argument was whether to buy equities when FED starts to reduce or increase its Federal Funds Rate. Since I am not a subscriber of that article, I thought maybe I could do a study based on freely available information.

I did a simple study based on data from Federal Reserve Board website [http://www.federalreserve.gov/fomc/fundsrate.htm]. The data is from 1990 to present.

Strategy 1
Let’s say we buy into stock market when FED begins to start cutting rates and exit the stock market when FED starts to increase rates. For the purpose of this study, I will use Dow Jones Industrial Average to represent the equity market.

This will be the outcome:


On average, the gain is about 20% with maximum draw down of 16%.

Strategy 2
If we were to do the opposite, that is, we buy into the equity when FED starts to increase rates and exit when FED starts to reduce rates.

This is the result:


The result shows that on average the return is 17% with maximum draw down of 9%

Comparing the 2 strategies, I like Strategy 2. That is I will buy equities when FED starts to increase rates and exit when FED starts to reduce rates. This is because the draw down is much lower. Strategy 1 although is able to give a higher average return, the draw down is also much higher.

This contradicts with the general belief in the market that the best time to buy equities is when FED starts to cut rates.

Of course, the data sample is not large enough to reach a strong conclusion. If anyone has a more complete historical data of FED rate decision prior to 1990, please contact me so that I can do a more complete analysis. Thanks!

And for those who celebrate Lunar New Year, have a happy and prosperous Lunar New Year. May the year of the rat brings in more profit for everyone. Gong Xi Fa Cai.