#federalreserve

What Happens to Stocks When the Fed Hikes

By:  Robert Verdugo, CMFC®, APMA®, Financial Analyst

As the Federal Reserve (the Fed) is poised to start raising rates today, and with the S&P 500 (1) down over 10% off its highs, is it time to declare the bull market dead? History would say no – in fact, a resounding no. Jess Menton’s article in Bloomberg, titled “What Happens to Stocks When the Fed Hikes: A Historical Guide”, does a quick dive into the historical performance of the S&P 500 after the first initial rate hike by the Fed.(2)

The previous 8 rate hike cycles all ended with the S&P 500 higher 12 months later, 50% of those instances had the market up after just three months.

The article also highlights the different sectors and their relative performance after the rate hike begins:

It makes sense that the technology sector would be the leader out of the gate, considering it’s typically the sector getting battered prior to the actual rates increase.

While this does argue the case that the bull run may still be intact, could there be a stumbling block (or two) that could make this time different? Absolutely, and it could very well be the reason why you’re gritting your teeth at the pump. According to the article, recent oil price surges may create a problem for the Fed. In the past, oil shocks have “… preceded economic downturns in the mid-1970s, early 1980s and early 1990s. But other recessions, like after 9/11 in 2001 and the global financial crisis in 2008, weren’t directly caused by a sharp rise in crude prices.” A second large reason for more volatility will be midterm elections this year, as they traditionally cause a ruckus for the markets in the preceding months before the elections.

The market is said to be forward looking, and it requires a very accommodating Federal Reserve to signal its moves. While it’s never been a perfect marriage, the stock market does its best to price in future actions in the current market. Is that what is happening during this correction? Only to start its rise after the hikes begins? Nobody knows for certain. What one can safely assume, however, is that more volatility is in store in the near future. Let’s also hope for a less stressful times at the gas station too, that would be nice.

  1. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market.
  2. Please remember that past performance may not be indicative of future results.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

The New Vigilantes

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The markets are all aflutter as the Federal Reserve (the “Fed”) plans to reduce and then eliminate their purchases of government securities which are supposed to follow their first increase in the Fed Funds rate in March. That is estimated to be a 25-basis point (maybe 50-basis point) rise. If you believe the latest estimates of the members of the Federal Open Market Committee (FOMC), by the end of 2024 the rate would be up to 2 1/8%. And their “longer-term” estimate is 2 1/2%.

All this is in connection with the switch by the Fed from their pipe-dream estimates of last year that the burst of inflation was “transitory”. Now, apparently, it is judged to be not. So, they are going to tame inflation by raising the Federal funds rate to 2+% and at the same time reduce the size of their $9T balance sheet by not reinvesting the maturing bonds that they hold. 

In a Goldilocks scenario, this should take care of the inflation threat by year’s end. All the while, economists see 10-year bond yields reaching 2.5% – 3%. With inflation still likely lingering about 4%, where are the bond market vigilantes of old, that forced interest rates high enough to choke off inflation (and in the process caused the two recessions of 1980 and 1982)? With inflation likely two times the level of the estimated Fed Funds rate, what mechanism will tame the inflation?

Well, ironically, oil prices reaching $100/barrel are likely to be the new “vigilantes”. With oil production being penalized by Western governments via taxation or regulation to limit oil drilling, and at the same time global economic growth is expanding as the Covid pandemic becomes endemic, oil prices could continue to rise toward $100/bbl. While there is nothing magic about that price level, it can do two things: 1) keep overall inflation rising above expectations, and more importantly, 2) depress economic growth enough to take the word “recession” out of the closet. That’s all the Fed will need (especially in an election year and their history of overdoing it) to “blink” and reverse course, especially if markets continue to be under pressure and politicians need to be re-elected.  

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

The Fed & Inflation

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

Source: Realinvestmentadvice.com

Has the Federal Reserve (the “Fed”) caused the burst in inflation over the past year? Not Likely.

While the Fed can influence money supply (M1) growth, they can’t control how fast it is spent. Money velocity measures how many times a dollar of money supply circulates. If M1 growth rises but it is saved (a decrease in velocity), GDP and prices will stagnate. In the 1970’s (circle) both M1 and velocity rose, causing rapid inflation. Contrast that to today, where the Fed caused an historic expansion in M1 to counter the pandemic/recession. But until recently, inflation was quiet as households and businesses hoarded cash and velocity plummeted. The supply chain wreck caused by the pandemic have been the major factors in elevating inflation, not “excessive” M1 growth.

But this speaks of the Fed’s policy impact on inflation. If/when velocity rises as Covid subsides and lockdowns end, economic activity is likely to rise, lifting velocity, and that may frustrate the Fed’s attempts to control inflation. It would largely be out of their hands at that point.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

The November Employment Head Fake

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The print of the monthly payroll employment number brings Wall Street cheers or anguish, filling the market airwaves with new prognostications of economic growth or stagnation. The November release was a clear example of such harrumphing.

According to the Labor Department, employment rose by just 210,000, far below the consensus of a 545,000 gain. The S&P 500 fell 1.2% and 10 bond yield fell 9 basis points to 1.33% on Friday, the lowest close for bond yields since late September. The word was the Federal Reserve may have to go slower in withdrawing their bond buying because employment is stagnating. There was some truth to the tale, however. The three-month average of monthly payroll employment gains slipped from 845,000 to 378,000, implying a labor market slowdown.

But under the hood, things appear much better, and the labor market seems to be doing just fine. First off, the unemployment rate fell from 4.6% to 4.2%. And the reason is that household employment is based on a monthly survey of the same 60,000 households which rose by 1.1 million workers. And it is the household employment measure that is used to calculate the unemployment rate, not the establishment survey that gets all the attention. Along with that increase, the labor force added 594,000 workers. That means that new entrants into the workforce were able to find jobs easily. Since unemployment is measured as a percent of the labor force, typically if employment gains are less than labor force growth, the unemployment rate rises. Not so in November.

But there is more. The labor force participation rate (the percent of the working age population looking for work and thereby in the labor force) rose to 61.8%, climbing out of the range it had been in since mid-2020. This is important because it shows that workers that have laid back looking for work for various reasons like federal and state unemployment assistance, are now willing and able to be employed.

While the markets viewed the November report as a sign of slackening in employment, more robust measures suggest otherwise. Along with the labor force participation rate, weekly initial claims for unemployment insurance have declined sharply over the past two months, from 364000 to 222,000, a 39% reduction, bolstering the message of continuing momentum on the job front.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

The Federal Reserve Taper Begins

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The Federal Reserve’s latest policy meeting last week finally put some meat on the bone by concluding they would start the tapering of their $120 billion monthly purchases of government securities. Though they were inexact as to the precise timing, it appears the program will begin in November and finish up by mid-2022.

But there were a couple of things in the Fed’s statement that took the market by surprise. The Fed issues a detailed quarterly summary of what members of the Federal Open Market Committee (FOMC) individually forecast about the next 3-year movements in inflation, economic growth, and the Federal funds rate. Those estimates are summarized in a Summary of Economic Projections (“dot plot”) where each of the 18 members (including Chairman Jerome Powell) map their projections on a three-year ahead calendar. It’s there where the changes since the June summary had market impact.

In their last “dot plot” in June, seven of the 18 members thought that the Fed should start raising interest rates by the end of next year, rather than in 2023. In the latest one, half of the committee determined that 2022 was more likely (when the tapering was finished). They also pushed their longer-term interest rate estimates higher. One reason appears to be that during the interval between June and September, annual inflation (CPI basis) rose to 5% as supply bottlenecks and rising wages continued to increase business and consumer costs. Elevated risks to their estimate of “transitory” inflation appear to have prompted Fed officials to begin their tapering and to revise their interest rate timing and to increase their interest rate projections. Market watchers dubbed this as a hawkish turn in Fed policy.

At the same time, however, employment gains slowed and high frequency economic data on retail sales and manufacturing and service activity weakened.  The specter of stagflation has begun creeping into economist’s lexicon, a legacy of the 1970’s. In previous meetings the Fed had emphasized that “substantial further progress” on employment would be needed for them to move to raise interest rates. In this meeting, the Chairman stated he is looking for “accumulating progress”, appearing to back off from his earlier statement.  With eight million people still unemployed and the slowing in employment gains, the Fed’s message seems to be that inflation is now a more pressing policy issue, especially if the gargantuan $3.5 Trillion spending bill is passed.

So, what has the market impact of all this been? Bond yields declined initially as some investors believed that the start of a less accommodative policy and a possible rise in interest rates in 2022 would forestall more rapid increases required later to confront inflation. But that sentiment didn’t last long. The Fed’s preparing to end its ultra-easy monetary policy has also signaled that the economy would continue to strengthen in the short term, putting upward pressure on interest rates, a view that shortly began to dominate bond market sentiment. Bond yields quickly turned higher. In fact, they have touched multi-month highs. And it didn’t help that several European Central Banks have either ended their bond purchase program (QE) or have begun raising rates.

Stocks were a different story. They reacted bullishly and interpreted the Fed moves as affirmation that the economy was on a solid growth path, giving confidence to expectations of healthy gains in corporate earnings. In fact, the S&P 500 registered its largest 2-day gain since mid-July at 2.2%. Small cap stocks (Russell 2000) rose 4.2% and banks have surged by 6 1/4%, indicative of investor confidence in the ongoing cyclical upswing. The long-term equity uptrend continues despite a changing Fed policy and an eventual rise in interest rates.

  1. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market. Price return quoted.
  2. The Russell 2000 Index is a small-cap stock market index of the smallest 2,000 stocks in the Russell 3000 Index.

Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Benefit Financial Services Group (“BFSG”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from BFSG. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. BFSG is neither a law firm, nor a certified public accounting firm, and no portion of the newsletter content should be construed as legal or accounting advice. A copy of BFSG’s current written disclosure Brochure discussing our advisory services and fees is available upon request.