Market Health

Can You Fight the Federal Reserve?

Wall Street’s advice has always been to not fight the Fed.

When the Fed is lowering rates, it’s time to be aggressive. It’s a time to put the pedal to the floor and look for moonshots on even the riskiest of assets.

And when the central bank raises rates, you should be fearful.

It’s a time to get more conservative and selective. It’s when many investors find U.S. Treasurys to be a cozy spot to snuggle in.

It’s the nature of the beast.

Everyone loves cheap money, especially Wall Street. And interest rates impact cash flow and buybacks.

But is a rising interest rate environment really that bad for stocks?

And can you fight the Fed?

Fight the Power

Investors chew their nails all the way down to the cuticles every time a Fed official speaks.

They’re fearful that the proverbial punch bowl is going to be taken away.

We’ve created this new normal where everyone is hyperfocused on the central bank, its asset purchases and “dot plots.”

Ten years ago, dot plot charts were introduced so financial news outlets and investors could agonize over how the 19 anonymous dots were arranged on the board… and hypothesize about which dot was whom.

But this isn’t how it’s always been.

Now, current central bank policy is a far cry from what it was almost two decades ago. And rate hikes are not always bad for stocks.

For example, from June 2004 to June 2006, the Fed raised rates 17 times.

The federal funds rate went from 1% to a gaudy 5.25%!

This was the strategy of former Fed chairs Alan Greenspan and Ben Bernanke to keep inflation in check.

And stocks soared to their highest level in years.

The Fed chose to keep rates elevated until September 2007. We’re all well aware of what happened then.

The economy showed signs of weakness. The housing and credit crises bubbled over. And the Fed had to alter its course.

The result is the world we’ve lived in for the past decade-plus.

Can Good News Be Good News Ever Again?

As we warned, September has been a choppy month.

But that’s just September’s long-term trend.

The looming anxiety over surging COVID-19 delta variant case numbers is capping momentum.

And then, we’ve seen glimpses of the “good news is bad news” trend that’s been with us since the aftermath of the financial crisis in 2007.

For example, August retail sales blew past expectations. They came in with a gain of 0.7%, well above the forecast of a 0.8% drop.

But instead of cheering, stocks dropped in response. Because we know that if the data is too good, the Fed is going to change course.

And the Fed has already suggested that it is willing to begin reducing asset purchases later this year.

Now, these “taper tantrums” in the market have been with us for more than a decade.

But despite the headlines, hoopla and doomsday scenarios, this turbulence rarely brings down the plane.

It seems like ages ago, but the last time the Fed raised rates was the end of 2016 through 2018.

The S&P 500 Index gained 21.83% in 2017. And it ended 2018 down 4.38%.

But don’t point to the Fed raising rates too quickly in 2018 as the culprit for the decline of the S&P 500. Admittedly, there were four hikes that year.

The big weight on stocks in 2018 was the trade war with China. The tit-for-tat tariffs were a path of mutual self-destruction that gutted industries on both sides of the dispute.

And that helped lead to a midcycle adjustment of three rate decreases in 2019 (with the S&P 500 gaining 31.49%).

So what I’m getting at is this: “Don’t fight the Fed” is a flawed piece of wisdom.

Fed rate hikes don’t concern me. They shouldn’t concern you because the bumpiness that a rate hike causes is short-lived.

Let’s say the Fed starts raising rates this year. It’ll likely be at a tiptoeing pace.

And the markets will continue to head higher as long as they’re not sideswiped by some exogenous threat.

Here’s to high returns,

Matthew

P.S. What do you think? Let us know in the comments.

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