Let History Be a Guide By Doug Kass Special to TheStreet.com 5/14/01 4:25 PM ET

In analyzing today's market cycle, I use history as my guide.

Past performances of markets or of horses (one shouldn't have to look further than my Kentucky Derby pick!), don't guarantee a thing. But past performance often provides a framework for what the future might hold.

In my April 10 column, I examined the (counterintuitive) notion that the equity markets tend to perform well in years when corporate profits are down and earnings disappoint relative to expectations. Indeed, the S&P 500 index actually rose in the five years since 1980 in which analysts' consensus estimates for it proved to be at least 15% higher than the actual results.

That is because the market is a discounting mechanism -- it often anticipates changes in the direction of a company's or industry's health -- both up and down -- well in advance of clear evidence.

That said, on March 26, I opined that the equity market was putting in an important bottom.

At the core of my bullish argument was the expectation that the Federal Reserve would lower interest rates to whatever level would revive the economy.

Today's column will focus on the historical relationship between aggressive monetary easings -- five consecutive rate cuts -- and the subsequent performance of the stock market.

The Federal Reserve is widely expected to reduce interest rates again on Tuesday. That move would mark the fifth rate cut by monetary authorities since the beginning of the easing cycle.

Since 1970, there have been five occasions when the Federal Reserve did a series of five cuts in the federal funds or discount rates (1971, 1975, 1982, 1986 and 1989).

The table below shows how the major market indices performed before and after those five interest rate cuts. (The first column shows how much lower or higher the indices were a year before the cuts, on average, than at the time of the cuts.)

Average Price Performance Before and After Fifth Interest Rate Cut (1970-2001)
Index	1 Year Prior	1 Month After	3 Months After	6 Months After	1 Year After
Nasdaq	-8%	+3%	+8%	+12%	+21%
DJIA	+7	+2	+6	+8	+18
S&P 500	+5	+3	+5	+8	+18
Source: Bloomberg

When I first posted these statistics in the Columnist Conversation on RealMoney.com on Thursday, Todd Harrison challenged their validity, claiming this time is different. In defense of his view, Todd cited the meteoric move in the market averages leading into this year's fifth cut in interest rates.

Todd's objection seemed reasonable, so I went on to examine how the market indices have performed in the 12 months leading into Tuesday's expected ease. I then compared that performance with the results in the first column of the table above (the average of the last five cut periods).

As the next table shows, all three major market indices have materially underperformed in the past 12 months, both absolutely and when compared with the average performance of the previous periods since 1970 when interest rates were cut on five consecutive occasions. Therefore, Todd's claim, at least measured by this time frame, loses weight. (I plan to back test, using longer time frames, during the week -- and will report my findings.)

Price Performance in 12-Month Period Prior to Rate-Cut Series
Index	Five-period average	5/15/2000-5/15/2001
Nasdaq	-8%	-45%
DJIA	+7	+1
S&P 500	+5	-10
Source: Bloomberg

Sectors, Sectors

A determined Federal Reserve and the implications that five consecutive interest rate cuts have had on stock prices -- coupled with my belief that a period of maximum fundamental discomfort, deceleration of profits and general uncertainty is behind us -- are among the more crucial pieces of that puzzle.

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