On Tuesday, the
rested, holding rates steady after 17 consecutive hikes. The next day, an interesting discussion took place on
Columnist Conversation after Norm Conley asked, "What can we expect from markets after the Fed stops raising?"
Conley cited a June 6 report by Calyon Securities, "Market Performance & Fed Tightening Cycle," which found "stocks performed quite well" in the six months that followed the end of tightening cycles over the past 25 years (the current cycle is the fifth). The prior cycles ended in August 1984, February 1989, February 1995 and May 2000, which was the exception to the upbeat rule.
Conley recently performed a similar analysis using various Russell indices and found that "on average, the Russell 1000 increased by 16.2% in the 12 months following the final tightening. The index increased an average of 37.9% in the 24 months following the last tightening. ... These average returns are inclusive of the thumping stocks took in the 12 and 24 months following May 2000."
In the past, I've looked at similar studies -- including some that have gone back to 1962, 1953 and 1929 -- and it turns out that the 1982-2000 period is somewhat unusual.
Indeed, 1980 seems to be a dividing line when it comes to the Fed. In the majority of cases from 1980 forward, markets did rather well after the Fed finished. Prior to that year, markets were generally lower six and 12 months after a tightening cycle ended.
In October 1982, the Fed shifted its emphasis from money-supply measures and "nonborrowed reserves" to an explicit fed funds rate-targeting procedure. That could very well be part of the basis for the change in results after Fed tightening ends. (See:
When Did the FOMC Begin Targeting the Federal Funds Rate? for more detail.)
My conclusion is that the
of the Fed hiking cycle is what matters most to markets. During secular bull markets, Fed tightening seems to cool inflation and allows markets to keep rising. During bear periods, the Fed cycle seems to stop just before a major economic slowdown begins. The decrease in revenues and earnings then pressures equity prices.
Let's examine some of these other studies. InvesTech Research looked at market performance over the following three, six and 12 months after the end of a tightening cycle, from 1929 to 2000:
S&P 500 Gain/Loss
The study found that prior to 1982, nine of 11 cycles ended with stocks lower six months later. From 1982 forward, markets have been higher two of three times. (Note that InvesTech did not include 1984 as a full cycle, which was a positive year for stocks.)
Next up: Ned Davis Research, which also compiled all of the Fed hiking cycles over the past 75 years. The organization found that, going back to 1929, the
was actually lower six months after the last rate increase 71% of the time, and down 64% of the time 12 months later.
The silver lining in the Ned Davis study was that, since 1980, the Fed has tended to start lowering rates -- on average -- six months after its increase. This may explain the bullish findings during the 1980-2000 period.
A third study was conducted by Birinyi Associates. It put together a composite chart of the post-Fed tightening cycles by creating an overlay of what all the tightening cycles looked like -- from the last hike to the first cut -- since 1962:
Source: Courtesy of Birinyi Associates
Note that the euphoria surrounding the end of the Fed cycle often leads to an initial 1% to 2% relief rally; that subsequently gives way to an 8% average drop, a 4% bounce, and then a revisit to the lows. The accompanying chart looks none too encouraging.
The fourth, and final, study is from Comstock Research. It looked at the 12 periods during which the Fed has engaged in a series of rate hikes over the past 53 years (1953 to present). Comstock concluded: "In 10 of those instances, the S&P 500 subsequently declined
the final rate increase, with an average drop of 22% to the eventual bottom. On average, the market bottom occurred 10 months after the end of tightening. Importantly, an economic recession followed in nine of the last 12 cases."
On a final note, Merrill Lynch's chief North American economist, David Rosenberg, took a very different tack. He goes one step further and notes that not only do markets exhibit "lackluster performance post-Fed tightening cycles," but points to periods of "financial crisis" shortly after the Fed goes on hold.
- When the Federal Reserve finished its tightening cycle by September 1987, markets plunged the very next month. "It wasn't a case where the Fed was tightening on the 16th and the market crashed on the 19th," Rosenberg writes.
- In May 2000, the Nasdaq Composite was flat year to date, following a rally and then a selloff. The Fed had ended its tightening campaign of six hikes in 11 months, including a half-point raise. Nasdaq lost more than 40% in the following six months.
- The Fed tightened rates seven times from 1994 to 1995. The strains on the economy were felt late in 1995, as GDP slowed to 1.1% and 0.7% the following two quarters and Treasury yields rose 30%. However, 1995 was a positive year for stocks.
In conclusion, since the formation of the Federal Reserve, the end of a tightening cycle has been a negative signal for equities.
The exception has been the recent tightening cycles during the 1982-2000 bull market. The cycles ending in August 1984, February 1989 and February 1995 were net positive, while the May 2000 -- well, I don't need to remind you what followed that cycle. Whether the change in fed funds targeting is partially responsible has not been conclusively determined.
The bottom line: The Fed stops tightening when it sees the economy slowing dramatically. The weakness affects revenue and earnings. With profits plummeting, all the supposedly cheap stocks (based on P/E) are suddenly not so cheap anymore. That leads to a market correction, which starts the entire process all over again: recession, cheap stocks, Fed cutting, buying opportunity.
Investors need to be patient, and not jump the gun on the upcoming buying opportunity.
Barry Ritholtz is the chief market strategist for Ritholtz Research, an independent institutional research firm, specializing in the analysis of macroeconomic trends and the capital markets. The firm's variant perspectives are applied to the fixed income, equity and commodity markets, both domestically and internationally. Other areas of research coverage also include consumer, real estate, geopolitics, technology and digital media. Ritholtz is also president of Ritholtz Capital Partners (RCP), a New York based hedge fund. RCP is driven by the analysis performed by Ritholtz Research. Ritholtz appreciates your feedback;
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