For the past 25 years, James Stack has published his InvesTech Market Analyst newsletter from his base in rural Montana, offering solid historical research on why bull markets and bear markets behave the way they do. A contrarian by nature, he likes to periodically re-examine core “truths” to see if they hold up to renewed scrutiny.

His current concern? The notion that once the U.S. Federal Reserve Board stops raising interest rates, stocks should really be on their way — a belief that almost everyone, it seems, subscribes to and one that Stack maintains does not stand up to historical scrutiny.

By 2003, the rate-setting federal open market committee had dropped the federal funds rate to a four-decade low of 1%, largely as insurance against deflation. Since then, the FOMC has hiked rates some 15 times. As a result, at 4.75%, the federal funds rate is now the highest it has been in five years.

Fed policy-makers want the U.S. economy to slow down in the coming months after projecting that it will grow 3.5% in 2006, the same as last year. But Fed chairman Ben Bernanke, who succeeded Alan Greenspan earlier this year, doesn’t yet know how high he will have to raise the rate to achieve that happy ending. If he raises it too little, inflation could take off; if he overshoots, he might trigger a slump.

Analysts pick apart every word from the Fed, looking for clues to its next moves on inflation, economic growth and interest rates. Adding to the markets’ anxiety is the widespread belief that the Fed, which has said inflation is still rising at an uncomfortable rate, will raise interest rates yet again when it meets later this month, perhaps pausing there.

And then what? Well, not necessarily higher stock prices, says Stack.

Higher interest rates can create a tough environment for stocks by crimping corporate profits, but also by attracting investors away from stocks and into bonds. Granted, the market did jump nicely earlier this year when the Fed suggested that significant rate hikes were less of a certainty. Despite this, however, Stack’s research suggests that whenever the end does come, the final blip in a series of Fed rate hikes signals a potential stock market decline — not an increase.

To substantiate his case, Stack has reviewed the instances in the Fed’s history in which it raised interest rates at least twice in succession. He then measured the gain or loss in the Standard & Poor’s 500 composite index following the final rate hike each time.

During the past century, on average the S&P 500 was lower three months later, six months later and only slightly higher a year later. Eliminate some of the most extreme examples — the Great Depression, for instance — and you still come up with similar results, he declares. The stock market on average generally declines over the six months following the final boost and is slightly less than 2% higher a year later.

The major exceptions to this general rule, says Stack, came when the Fed not only stopped raising rates but soon after let them decline — a scenario that few observers see as being likely this time, at least in the short term. So, if we assume that the Fed will stop increasing rates within the next three months or so, the stock market is unlikely to do well right away.

Tom Sowanick, chief wealth-management strategist at Merrill Lynch & Co. Inc. doesn’t agree. While he admits that sharply higher long-term interest rates (significantly more than 5% on the 10-year U.S. treasury note, for example) could derail U.S. stocks, he thinks a plateau in rates will be good for stocks. Companies appear to be poised to increase their earnings at an above-average clip for the fifth year in a row, he says, which suggests that dividend payouts will be healthy again this year.

He expects that U.S. equities should respond positively to the end of the Fed’s tightening cycle from the outset, especially as productivity continues to be healthy.

Stocks seem to be inexpensive in relation to bonds, he suggests, and their income-growth potential appears to be greater than that offered by current bond yields. IE