V.8:1 (31-32): Stock timing to the discount rates by Jay Kaeppel

Stock timing to the discount rates by Jay Kaeppel

The course and direction of interest rates have long had a direct and often profound effect on the course of stock prices. When interest rates are rising, investors tend to turn away from the stock market and lean more towards interest-bearing investments, such as Certificates of Deposits and Treasury bills. However, when interest rates begin to decline, investors look to the stock market as an avenue to increase their returns, as the returns on their interest-bearing investments decline. One of the most useful interest rate measures is the Federal Reserve Board's (the Fed) discount rate.

The discount is the rate that member banks pay to borrow money from the Fed. It is an important rate because it is directly controlled by the Fed, and the Fed has a great deal of influence over the direction of interest rates, inflation and, therefore, the economy. In most cases, the discount rate is not a leading indicator. However, it is extremely useful for identifying the underlying tone of the stock market.

Generally, a declining trend in the discount rate is much more bullish for stocks than a rising trend in the discount rate is bearish for stocks. When the discount rate is declining, stock prices invariably go up. When the discount rate is rising, stock prices do not always go down, but the last two major bear markets (1969-70 and 1973-74), were both preceded by a hike in the discount rate, as was the 1987 crash.