On January 3rd, 2001, the FED began a long string of rate cuts that would eventually bring the Fund rate to 1% by mid-2003. The impact felt by the housing market is now conventional wisdom, but the Stock market remained stubbornly unfazed long after. In fact, the S&P was close to 1,200 in early 2002, but could still not break away from the 800s by early 2003.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), was signed on May 28, 2003. Many, and count me in, view JGTRRA as a key catalyst for the Stock Market rally, which took the S&P from 800 to past 1,380, a gain of over 70% in only two and a half years.
The Stock Market has remained undeterred by the 17 FED rate increases since June of 2004. Housing however has once again proven to be an early indicator, one alas very susceptible to the vagaries of interest rate direction. In fact, just last month, housing prices saw its biggest drop in 35 years.
As the Democratic Party, which rejected JGTRRA by a wide 96.6% margin (House vote), regains control of Congress, one could expect that JGTRRA will sunset, as currently planned, by the end of 2008.
Without regard to political views or macro-economic factors (e.g. fiscal deficit), I suggest that the S&P will see a reversal back to 1,200 during 2007. This correction will be triggered by the opposite factors that brought the 2003 rally - higher rates and JGTTRA sunset.
Moreover, I suggest that the concomitant stock and housing market corrections will be catalyst to a mild recession, one which will last through the 2008 election cycle.
The political ramifications of "It Takes Two" will be the subject of a different post.