DON’T EXPECT THE FED TO END THIS BULL ANYTIME SOON
Jeff Buchbinder, CFA, Chief Equity Strategist, LPL Financial
Ryan Detrick, CMT, Chief Market Strategist, LPL Financial
The Federal Reserve (Fed) has engineered a massive hawkish shift, causing a bit more stock market volatility recently. But how worried should investors be? Here we take a look back at historical performance for stocks before, after, and much after initial Fed rate hikes to help reassure any nervous investors out there. We also take a quick look at what the Fed pivot could mean for growth/value and large cap/small cap trends given the maturing business cycle.
MASSIVE HAWKISH SHIFT
With the recent pivot by Jay Powell and Company at the Fed, rate hikes have been getting a lot of attention. And rightly so, given the bond market has gone from pricing in one 2022 rate hike just a few months ago to now pricing in three to four. That’s one of the most dramatic hawkish shifts by the Fed in a short period of time that we’ve ever seen, so some market jitters are not surprising.
HOW MUCH SHOULD WE WORRY?
A look back at history may help calm some investors’ jitters around the start of Fed rate hikes. As we wrote in our Outlook 2022: Passing the Baton, stocks tend to do well leading up to initial Fed rate hikes. There we highlighted the average 15% gain during the 12 months ahead of the initial hike of an economic cycle, including gains in all nine cases back more than 60 years. This makes sense given it takes a strengthening economy to create the job gains and inflation the Fed needs to see to take away the punchbowl. We see the first rate hike coming in either March or May, and with the S&P 500 Index up nearly 20% since March of 2021, and more than 10% since May 2021, those gains may already have occurred.
Looking beyond the initial hike, on our LPL Research blog last week we looked at how stocks performed during various periods after the Fed starts to hike rates. The story is similar, with the S&P 500 up an average of 7.5% six months later and 10.8% over the next 12 months historically. Stock were up all eight times one year after those initial hikes going back to the early 1980s. So based on history, the start of a rate hiking campaign by the Fed should not be too worrisome for investors.
LOOKING OUT LONGER TERM
But what does the hike mean further out, say 2023 and beyond? In Outlook 2022, we noted that initial Fed rate hikes can help us mark where the economy is in its cycle. The start of rate hikes typically happens in the early-to-middle stages of the cycle, where stocks historically see solid gains as we are forecasting for 2022.
But we can extend this exercise further and look at how stocks have done from the initial rate hike of a cycle until the end of the accompanying bull market, as we have done in [Figure 1]. Those first rate hikes have been followed by an average gain of 67% before the subsequent bull market peak. For those keeping score at home, that would take the S&P 500 to over 7,700 (no, that is not a forecast) before the next 20% or more decline.
On average, after rate hikes start, bull markets have run for about three to four years (or 40 more months) before peaking, with the longest in the late 1990s at six years (72 months) between the 1994 hike and the bull market top in March of 2000.