The Federal Reserve’s rate hike campaign will inevitably come to an end, but this long-awaited “Fed pause” may not be the bullish development for which many are hoping, cautions Jim Stack, a leading money manager, market historian and editor of InvesTech Research.
Indeed, we would ask, “Will a Fed pivot even matter?” Investor psychology is currently dominated by the belief that a pause in Fed tightening is guaranteed to bring an end to this bear market. Yet, viewing final rate hikes from a historical perspective paints a far less optimistic picture.
* 8 of 16 historical instances resulted in a maximum loss of more than 20%.
* 2 of the past 3 final rate hikes were followed by a maximum loss of nearly 50%.
* On average, when it comes to tightening cycles that occur in bear markets, the majority of the bear’s losses still lay ahead after the final rate hike.
So, while the Fed has been the catalyst for pain in financial markets this year, history shows that a pause in Fed tightening is not a reason to throw caution to the wind. Monetary pressures continue to flow through to the economy with a lagging effect, and many times the Fed’s final rate hike comes too late, especially when a bear market is underway.
A pause in the Federal Reserve’s hiking cycle isn’t automatically bullish, and even a full policy pivot may not be enough to overcome bearish forces. A prime example of this is the 2007-09 bear market.
Starting prior to the onset of that bear, the Fed cut rates 12 times from August 2007 through December 2008, bringing rates down to what was the lowest level in history at that time (see graph at left). Despite these efforts, the S&P 500 ended with its largest bear market loss since the Great Depression.
A similar dynamic occurred during the unwinding of the Tech Bubble, when 11 rate cuts also failed to end that 21⁄2 year-long bear market. We fully expect that any news of a pause or pivot in Fed policy could induce another strong short-term rally. However, it would be a mistake to hang your hat on the idea that a change in monetary policy alone will ignite a new bull market.
2023 could prove to be even more dangerous for investors, as leading economic indicators are almost unanimously sending a strong warning of recession. Furthermore, a recession could be exacerbated by falling home prices and restrictive monetary policy as the Federal Reserve contends with persistently entrenched inflationary pressures.
Successfully navigating bear markets is always a tall task, and more protracted bear markets require great patience and discipline. It’s an emotional roller coaster and bear market rallies can be very enticing. Consequently, it’s important to remain objective and to never underestimate the downside risk.
As we enter the new year the weight of evidence remains decidedly negative. As a result, InvesTech's Model Fund Portfolio is defensively positioned with a net invested allocation of just 38%.