Don’t Fear the Rate Hike

Image Credit: Samer Daboul (Pexels)

Historically, Tightening Cycles Have Not Caused Long-Lasting Market Damage

The Fed does not plan on having a tight monetary policy, just a less easy one.

On March 16, 2022, the FOMC Committee announced their intention to target a fed funds rate that would be 0.25% higher than it had been. It was the first increase since December 2018, and the hike more than doubled this key interest rate. Fed Chair Powell made it clear it would not be the Committee’s last.

Less than two months later, on May 4, the Fed adjusted the overnight target by an additional 0.50%. This was the largest increase since the year 2000.   But they were just getting started. They suspected they had fallen behind in their mandate of keeping inflation down. Stable prices generally mean balancing supply and demand, and since the Fed couldn’t do much to raise the consumable supply, they acted to dampen demand. They made money more expensive. In mid-June, the Fed hiked by 0.75%, in late July it pushed them up by 0.75% again, and that was the last time the FOMC met.

The next meeting will be held September 20-21st. The perceived guidance is that they will raise rates again by a similar amount as they did in June and July.

Tightening Cycles

The current tightening cycle is a concern for those that fear that it may lower asset prices and lower business activity. The concerns are warranted as tightening cycles are designed to do exactly that, tame prices and slow economic growth. It’s tough medicine but is supposed to provide for better economic health long term.

Over the past 30 years, the Fed has convened four recognized tightening cycles – periods when it increased the federal funds rate multiple times.

Source: Federal Reserve

Over three decades, the median number of rate hikes per period is eight, and the median time frame is 18 months (from first to last). How has the economy and markets fared through this recent history? Only two of the periods, the one ending in 2000 and then in 2006, were associated with a recession. In all four cases, the market retreated at first.

If one uses GDP as a measuring stick for an economy that is either growing or receding, then the U.S. was in a recessionary economy for a calendar quarter before the initial 0.25% hike. So the tightening may not put us into a recession, but it does have the potential to retard growth further for a  deeper recession.

Market Performance

Markets have traded lower in the months following the start of a tightening cycle, but in each of the periods defined above, they have ended higher one year later. It would seem that the market fear of what slower growth would do for companies and stock prices were front-loaded; those fears then gave way to buying as expectations became better defined.

Source: Koyfin

For the tightening cycle that began in 1994, a year after the Fed first took aim at the economy, the S&P 500 Index had already bounced off its low and climbed rapidly to end the 12 months with a positive 2.41% return. At it’s worst, the index had given up 6.50%.

Source: Koyfin

Four months after the tightening cycle began in 1999, the market began marching higher and crossed the breakeven point three times. The first time in August, just 45 days into the cycle, and the last one in May of 2000. For the 12-month period an investor in the index would have gained 5.97%.

Source: Koyfin

In 2004 the tightening cycle again began on June 30. Stock movement over the 12 months that followed are very similar as 1999. For investors that held for five months, (assuming their holdings approximated this benchmark) they were treated with returns of 4.43% 12 months later.    

Source: Koyfin

The most recent tightening cycle was seven years ago and began in December. Those invested in securities in 2015 that followed the overall stock market quickly broke even, and for those that held, they were up 10.81% a year later.

On average over the four periods the S&P 500 returned better than 6% after the Fed began a prolonged tightening cycle. The median drawdown is observed to be 9% in the first 49 days following the Fed’s first rate hike. For those that were invested in stocks that were more closely correlated to other indices, their experience was different.

Other Indices (Small Cap, Value, Growth)

Source: Bloomberg

The best average, although it did have a negative return in one of the periods, is the performance of the small cap Russell 2000 index. Investors in small cap stocks would have earned almost twice as much (11.30%) as those invested in the S&P 500 Large cap, almost three times as much earnings as those invested in the Russell 1000 Value stocks, and far more consistent and more than three times the Russell 1000 Growth index.

Take Away

This is not the first time the Federal Reserve has raised rates and implemented a tighter monetary policy. In the past it has not meant doom for the economy. In fact, the policy shift is intended to preserve a healthy economy before it begins causing larger problems for those that depend on jobs and stable prices along with a orderly banking system.

The most recent tightening cycle began six months ago. If history is an indicator, it may last another year, during that time stocks will rebound to a level higher than they were in March when the cycle began. While there are no guarantees that history will accurately point to the future, it helps to know what happened the last four times. Investors may also look to increase their allocation into small cap stocks as they have by far outpaced other indices.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=PRATES

https://www.forbes.com/advisor/investing/fed-funds-rate-history/

https://www.putnam.com/advisor/content/perspectives/

The Fed Gets Inflation Tips from Cathie Wood

Image Credit: Meghan Marron (Pexels)

Ark Invest’s Cathie Wood Finds the Federal Reserve Quixotic

On Wall Street, staying with the herd guarantees average gains or losses. Wandering far from the herd adds two more possibilities. You may still have average performance, you may exceed the averages, or you may get slaughtered. ARK Invest’s Cathie Wood likes to explore her own field in which to graze, far from the herd. This preference shows in her funds performance. At times her returns have far exceeded competing hedge funds, and at other times they fall well below the pack.

In October of 2021, before Fed Chairman Powell changed his thinking that inflation may not be transitory, the renowned hedge fund manager, and market guru, Cathie Wood began sounding alarm bells about her fear of deflationary pressures. At the same time, she warned of job losses due to displacement as technology would reduce costs and the need for the current skill sets in the labor force.

For months renowned investor Cathie Wood has said that the Federal Reserve should stop raising interest rates, that the economy is seeing deflation rather than inflation, and that it is in a recession.

Even as others in the”transitory” camp have come more in line with the official position of the Fed on inflation, she has remained steadfast to her idea that new technology will solve supply issues. Supply is an important inflation input, and that innovation may oversupply to a point where the economy may struggle with falling prices.

This week she tweeted a few reasons for her forecast and shared her thoughts on Jerome Powell’s address at the Jackson Hole Economic Symposium.

Her view is that the Fed has overshot the target. Wood, who was already working on Wall Street during the high inflation 1970’s, tweeted her reasons for this belief. High on her list is the price of gold (expressed in dollars) which she says is one of the best inflation gauges. Gold, she tweeted,  “peaked more than two years ago.”

She also reminded followers of the price movements of other commodities, all down. These include lumber’s price decrease of 60%, iron ore 60%, oil 35%, and copper 30%. Much closer to final consumer prices, she highlighted that retailers are flush with inventories that don’t match the selling season. They’re discounting to clear shelves which could result in a deflation print in one of the more popular inflation gauges.

The Fed chairman who last fought inflation with unblinking resolve is Paul Volcker. Ms. Wood reminded her Twitter followers that the inflation he was battling had been “brewing and building for 15 years.”  In comparison, she said inflation under Jay Powell’s watch is only 15 months old and Covid-related.  She thinks the current Fed Chair has gone too far, and “I wouldn’t be surprised to see a significant policy pivot over the next three to six months,” Wood said.

A Quixotic Fed?

Powell and his colleagues are looking at the wrong data, Wood tweeted. “The Fed is basing monetary policy decisions on backward indicators: employment and core inflation,” she tweeted.  “Inflation is turning into deflation,” she said in another tweet.

Wood said, comparing the two Fed chairpersons, Powell invoked Volcker’s name four times in the Jackson Hole speech.  Her tweets explained inflation was much higher in Volker’s era.  “Until Volker took over [of the Fed] In 1979, 15 years after the start of the Vietnam War and the Great Society, did the Fed launch a decisive attack on inflation,” Wood detailed.

“Conversely, in the face of two-year supply-related inflationary shocks, Powell is using Volker’s sledgehammer and, I believe, is making a mistake.”

Take Away

Without different opinions and different investment holding periods, there would be no market. We’d all speculate on the same things, and they’d continue upward until the last dollar was invested.

Ark Invest’s flagship Arc Innovation ETF (arkk) has fallen 55% this year, more than double the fall-off of the indexes. When discussing current performance Wood has defended her strategy by reminding others that she has an investment horizon of five years. As of Sept. 7, Arc Innovation’s five-year annualized return was 5.81%.

Cathie Wood has continued an almost year-long campaign warning of deflation and saying the Federal Reserve should stop raising interest rates, and that the economy is in a recession. If she is right and has selected the investments that benefit from being correct, then those invested in her funds will be glad they placed some of their investment funds away from the herd.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://twitter.com/CathieDWood/status/1567648675635073025

www.koyfin.com