But that was then. Is anything really 'normal' anymore? Academically speaking, it's supposed to be, and to a certain degree it is. But as far as your investments are concerned, things aren't 'normal' enough anymore to make the same bets you used to be able to make. That's not a problem, except for one painful fact - the advice and ideas you're usually getting are based on models and norms that have long been outdated. In other words, be leery of those who frequently use the phrase "in a normal environment...." Their standard for normal may be from a different era, and too much has changed since then to be using the same rules.

One of the old norms that has become a myth in the modern era is that rising interest rates are bad for the stock market.

The problem is, it's not exactly true. The evidence shows that there's very little correlation between interest rates and stock gains. There's supposed to be a correlation, intuitively. But that model makes the assumption that economic data is logically priced into stocks, and that the economic cycle is synchronized with the market cycle. The fact of the matter is that logic rarely prevails when it comes to stock prices, and the economy and market often move independently of each other.

Listed below are all of the major, prolonged interest rate increases since 1970, as measured by the Fed Funds rate. The gain or loss for the S&P 500 during that same period is also listed. The results may surprise you.

* Feb. 72 to July 74: The Fed Funds rate rises from 3.3 to 12.9. The S&P 500
moved from 106.57 to 79.30. The market lost 25.5% during that time.

* Jan. 77 to June 81: The Fed Funds rate moves from 4.6 to an all-time (modern era) high of 19.10. The S&P 500 moved from 102.2 to 131.21. That's a 28.3% gain.

* Feb. 83 to Aug. 84: The Fed Funds rate moves from 8.5 to 11.6. The S&P 500 moved from 148.05 to 166.67. That gain totaled 12.6%.

* Oct. 86 to March 89: The Fed Funds rate rises from 5.8 to 9.8. The S&P 500 went from 243.97 to 294.87 (and this includes the 87 crash). The market gained a net of 20.8% here, despite the 24% loss suffered over October 16th and 17th of 1987.

* Dec. 92 to April 95: The Fed Funds rate moves from 2.9 to 6.0. The S&P 500 rose from 435.70 to 514.70. That was an 18.1% gain.

* Jan. 99 to July 00: The Fed Funds rate moves from 4.6 to 6.5. The S&P 500 moved from 1279.63 to 1430.85. That's a gain of 11.8%, even though it includes the very beginning of a huge bear market.

* July 03 to now: The Fed Funds rate rose from 1.0 to 4.1. The S&P 500 has risen from 990.30 to 1266.85. That's a market gain of 27.9%, and still counting.

See anything interesting? The market only lost ground in one of the last seven rising-rate environments. Not only does history show us that rising rates don't hurt stocks, we can actually see that we're better off by staying bullish when rates are rising.

Not what you've been told by all the talking heads on TV ? True, you don't have to look very far to find an expert telling you the opposite of what you just read. It seems that the media - and therefore investors - have been hanging on the Fed's every last word since the 1980's, just trying to get an early start on the selling if rates are going to creep higher. However, nobody ever really stopped to check if the strategy made sense. Factually, the evidence says it doesn't make sense to bail out of stocks when rates are going higher. Yet, it's unlikely that you'll get that information or opinion from anyone on Wall Street, since the truth can sometimes interfere with a good sales pitch. The next time you hear someone tell you to worry about rising rates, just ask them to explain the results cited above.

But wait a second! If the gurus are talking stocks lower, and investors are selling because of it, shouldn't that be enough to create the bearish environment that the market is worried about in the first place? The if/then logic is actually pretty sound there, except for one thing......the selling part. Remember this mantra....."Do as I do, not as I say". One of the ground rules of this book was that nothing would be cited as truth if it couldn't be proven. Theoretically, if the market is inspired to sell rather than buy, then stocks will indeed go lower. Investors may have said they were going to sell, but they reality is that they didn't. Instead, the vast majority of the time, stocks end a rising rate period higher than where they started it. The ONLY way that can happen is if there are more buyers than sellers (net) during that time. End of story. That fact isn't up for argument, nor are the historical results.

So what are they talking about?

Good question. In their defense, almost all seven of those periods had a rough patch within them where stocks were weak, if not slightly bearish. (It is true that during periods of rising rates, the market doesn't do quite as well as it does in periods of falling rates, as we'll see later.) On the other hand, when isn't there a rough patch, even when rates are falling? That's just the nature of the market, but perhaps that's what they're concerned about when they tell us to fear rising rates. The problem is that (1) the rough patch is not a certainty, and (2) the rough patch is still impossible to time within the rising rate environment, and (3) investors are leaving gains on the table by avoiding stocks just because rates are on the way up. In any case, in terms of total and complete results, the pundits are wrong about rising rates sending stocks lower, as we just saw. If anything, any dip stocks make in a rising rate environment is a buying opportunity.

So then how did we learn to fear rising rates in the first place?

Again, good question.

The better argument for the typical pundit might be that it's just excessively high interest rates that stifle the economy enough to send stocks lower. Even then though, the results of high interest rates are too inconsistent to say that there's a cause-effect relationship. But, just for the sake of fair play, let's take a look at what history has shown us about the points in time when the Fed Funds rate was painfully high.

How do we measure 'too high'? For our purposes, we'll just define any interest rate that the Fed sees fit to lower as being 'too high' for the economy to handle. So, we'll just assume that a falling Fed Funds rate is an indication that interest rates were previously 'too high'. The nice part about that methodology is that it allows us to compare the ridiculously high interest rates of the 70's and the 80's to the rather contained interest rates of the 90's. We need that apples-to-apples format, since we'll probably never see a Fed Funds rate of 19.1% again, as we did in 1981.

In any case, since 1970, we can see six periods of major declines in the Fed Funds rate. These periods, as you may expect, immediately follow the periods of interest rate increases we've already analyzed. Perhaps it is here where all the negative impacts of high interest rates finally materialize. After all, if rates are headed lower, it can only be because the economy is facing major hurdles that will (eventually) adversely affect the stock market.....right? Let's see.

* July 74 to Jan. 77: The Fed Funds rate falls from 12.9 to 4.6. The S&P 500 rises from 79.30 to 102.2. That gain totals 28.8%.

* Jan. 81 to Feb. 83: The Fed Funds rate sinks from 19.1 to 8.5. During that time, the S&P 500 rises from 129.55 to 148.05, to gain 14.2%.

* Aug. 84 to Oct. 86: The Fed Funds rate moves from 11.6 to 5.8. The S&P 500 moved from 166.7 to 243.97, gaining 46.3%.

* Mar. 89 to Dec. 92: The Fed Funds rate falls from 9.8 to 2.9. The S&P 500 went from 294.87 to 435.70. That's a 47.7% gain.

* May 95 to Jan. 99: The Fed Funds rate falls from 6.0 to 4.6 (the smallest move of the six in question). During that time, the S&P went from 533.39 to 1279.63. That's a monster gain of 139.9%.

* Nov. 2000 to July 2003: The Fed Funds rate falls from 6.5 to an incredible 1.0. The S&P 500 fell from 1314.95 to 990.3, losing 24.7%.....and had been even lower than that 990 level.

As you can tell, stocks only lost ground once out of these six instances. Again, not only was the market not hindered while rates were on the way up, it wasn't hindered while they were on the way down either. So, when exactly is the high interest rate issue supposed to drag stocks lower?

Maybe there's just an absolute (static) level of interest rates that finally stifles the market? Intuitively the answer seems like it should be 'yes'. But, the answer is no. In the mid-70's, when the Fed Funds rates creeped above 8.0, stocks got hammered. For most of the early 80's, the Fed Funds rate was above 8.0 percent. During that time though, the S&P 500 gained 88.2%. The Fed Funds rate spent a few months above 8.0 in the late 80's, as the S&P 500 gained a modest 11.7 percent. The market results differed in all three instances, even though the Fed Funds rate was at the same 'too high' level.

Looking for something a little more contemporary? No problem. Remember when rates were through the roof in the late 90's and early 2000? The Fed Funds rate peaked at 6.5 percent in June of 2000 (and then tapered off), when the bear market really kicked in. Well, guess what - the Fed Funds rate peaked at 6.0 percent (then tapered off) in 1995, which was the beginning of a monster bull market. Again, it was the same basic interest rate scenario, with two very different results.

The fact of the matter is that there is no functional correlation between interest rates and stocks. That's not to say that interest rates don't affect stocks, because they do. The point being made here is that there is no correlation that any investor could use to actually improve investing decisions or time the market. Sometimes rates move higher before a bear market, and sometimes after. Sometimes there is no bear market at all during a period of rising rates. Any speculation based on rates would be just that......guesswork.

The smarter move may be to ignore interest rate changes, since they can't really be capitalized upon. The market has been more bullish than bearish, regardless of what effect interest rates were supposed to have. Plus, there's no discernible pattern, timeframe, or specific interest rate level that has been consistently predictive. Undoubtedly, some of you will buy into that notion based on the facts. Some of you will not buy into that despite the facts. Some of you may even argue the point. It doesn't change a thing though. If you're making major investment timing decisions based on interest rates, you're wasting your time.

That said, many of you will also have noticed that the market gains during periods of falling rates are far greater than the gains made when rates are on the way up. That's not an assumption - it's a fact. In fact, one could argue that excessively high rates are what fuels the market's biggest gains. Perhaps this is the concern that's being voiced when you hear the hysteria of rising interest rates....things aren't quite as good then. However, history (and the math) shows that as an investor, you should be inclined to add positions to a portfolio when rates are rising, as well as when they are falling. That's not the point though....at least not yet. For the time being, just keep in mind that there is no empirical evidence that says higher rates are a reason to be out of the market.

Don't confuse that with the typical sales pitch you may hear from a broker. The advice you'll get (usually) is to stay 100% invested 100% of time, since you don't know when the market is going to rally. That's nonsense. There are many good reasons to be out of stocks. That 'buy and hold' dance just means they don't know when the market will rally. Or, it means they don't know how to best maximize the upside of rising rates (or minimize the downside). That doesn't mean you can't know. In a later chapter we'll discuss what stocks are best suited to provide maximum gains for rising and falling interest rates.

Follow Up Thoughts......

A challenging idea? That's an understatement. I asked some of my colleagues to review this portion of the book (which is still a work in progress), and they all pretty much said the same thing - that I was crazy for even bringing it up. Even if I was right, ignoring interest rates flies right in the face of common knowledge. While I appreciate their concern, I really can't say something I know to be untrue. The fierce adherence to a premise that hasn't been tested is probably why most Wall Street 'pros' don't beat the market. I suspect if the average fund manager would actually verify the ideas that he or she was making decisions with, the returns of their respective funds would improve greatly. I don't see that happening anytime soon though.

That's not ego talking....I have no ego when it comes to making money for clients. In fact, the lack of ego within our research staff is why we're consistently profitable. The only thing I want for clients is accurate and profitable data. The fact of the matter is that history has shown that interest rates have no functional correlation with stock prices.

Conclusion: There are plenty of reasons you shouldn't be in the market at various points in time. It's just that interest rates having nothing to do with any of those valid reasons.