How to Play the Federal Reserve’s Decision This Week
The markets hate uncertainty.
And, boy, are there some humdingers hanging over investors’ heads at the moment.
We have the Federal Reserve’s two-day policy meeting beginning today and stretching through tomorrow.
Then there’s the COVID-19 omicron variant trying to overshadow the holiday season.
Now, in algebra, it’s not that difficult to solve for two unknowns. But in the real world, it’s something investors are struggling with. At least, it’s something they are struggling with to start this week.
Fortunately, we already know the ultimate outcome, even if the rest of the herd has momentarily forgotten.
What Is Normal?
At this point, I think it’s hard for anyone to remember what “normal” monetary policy looks like.
Obviously, modern central bank policy is a far cry from what it was 20 years ago, let alone the near-apocalyptic stagflation of the 1970s and early 1980s.
The federal funds rate has hovered at nearly 0% for much of the past decade. And any potential shift away from that easy money level tends to incite panic… albeit briefly.
But let me be clear, rising rates aren’t necessarily bad for stocks.
From June 2004 to June 2006, the Fed raised rates 17 times.
And again, we were coming off an exceptionally low level then. But the federal funds rate went from 1% to a pre-dot-com-collapse rate of 5.25%!
We can see how steeply rates went up under former Fed chairmen Alan Greenspan and Ben Bernanke as they sought to keep inflation in check.
It’s also worth noting that stocks soared by double digits during that stretch.
The Nasdaq Composite and S&P 500 Index gained roughly 15% as the Dow Jones Industrial Average moved 13% higher.
Now, stocks didn’t recapture their glorious levels of the dot-com days. But the markets didn’t crash. At least not before the Fed chose to maintain elevated rates until September 2007.
At that point, stocks cratered in a dramatic and devastating fashion.
And the economy grew weaker as the housing and credit crises bubbled over.
The rest is history.
Rocking the Boat
“Taper tantrums” aren’t going to go away.
But the disaster doesn’t come from increasing rates. It comes from keeping them elevated for too long.
The last time the Fed raised rates was at the end of 2016. And that lasted through 2018.
The S&P 500 gained 21.83% in 2017. And it ended 2018 down 4.38%.
Now, accusing the Fed of raising rates too quickly in 2018 was a popular complaint. And there were four hikes that year.
But the trade war with China was the biggest contributor to the drop at the time. And all of that played out right before Christmas. (Does that sound familiar?)
The rate increases and the tightening of monetary policy have been telegraphed for months. And I’d argue that the market already has three rate hikes baked in for 2022.
The only answer we’re looking for now is whether they are going to begin in March or in May.
And that unknown will be determined by how the omicron variant plays out in the weeks ahead.
But the threat of the Fed cranking the federal funds rates as it did from 5.5% in 1977 to 16.4% in 1981 – or from 1% in 2004 to 5% in 2006 – is likely off the table.
We’ll likely see some jitters during these next few days, but new all-time highs will be sure to follow.
That means that you should stay invested, stay long and look for opportunities in the dip.
Here’s to high returns,
P.S. As the year comes to a close, investors are wondering how to position themselves for 2022. To find out whether we think growth stocks or value stocks are the way to go, click here.
Is This the Buy Signal Investors Have Been Waiting For?
January 24, 2022
The Compound Growth Approach to Financial Planning
January 13, 2022
Breaking Down One of Wall Street’s Biggest Lies
January 4, 2022