There is news this week that inflation October’s slower-than-expected slowdown further cements the view: United States Federal Reserve The most aggressive campaign to raise interest rates in four decades is over.
This could be a boon for the stock market and your 401(k).
Analysis by Ryan Detrick, chief market strategist at Carson Group, shows that of the past 10 rate hike cycles since 1974, the S&P 500 has fallen behind 12 times after the Fed finally raised rates. The average increase during the month was 14.3%.
By comparison, the index’s five-year average returns through 2022 are 7.5%, 10-year returns are 10.4%, 30-year returns are 7.5% and 10% over the past century, according to the index. Nerd Wallet.
Investors are really happy when central banks stop crushing them with interest rate hikes.
What happens when the Fed raises interest rates?
Rising interest rates push up costs Mortgage, car loan, Credit card purchase Detrick said these and other loans have stifled economic activity and eroded corporate profits. They also make stocks a relatively less attractive investment than bonds, which carry less risk with today’s rising yields.
Of course, the pain is ostensibly for good reason — curbing potentially entrenched inflation, at least according to the Fed, could do more damage.
Adam Turnquist, technical strategist at LPL Financial, said halting interest rate increases would have the opposite effect, brightening the economic outlook and making stocks more attractive than bonds. This also removes huge uncertainty from the market.
Is the stock market recovering?
From the day the Federal Reserve began raising interest rates in March 2022 until last Monday, the S&P 500 experienced some wild swings, but ultimately stalled at 4,411 points. However, the benchmark index has gained more than 100 points, or 2.3%, since the Labor Department released a favorable Consumer Price Index report early Tuesday.
“If July is the last rate hike, which we think it is, then historically stocks have done pretty well one year after the last rate hike,” Detrick said.
LPL Financial’s Turnquist called it a “catalyst for the stock market.”
There are some caveats.
First, Fed officials said they were not ruling out further rate hikes even after the encouraging inflation report, even though most economists thought so.
What impact will the interest rate pause have on the market?
While the end of rate hikes has fueled double-digit market gains in eight of the 10 rate hike cycles over the past half-century, the S&P 500 suffered severe 12-month losses in two of those cycles. loss. Stopping interest rate increases in July 1981 could not “avoid a 16.4% market decline amid brutal economic conditions. economic recession The trigger is that interest rates remain mired above 17%.
Likewise, the June 2000 interest rate hike could not prevent the 2001 dot-com recession.
“The (dot-com) bubble has burst, limiting the impact of the pause and subsequent rate cuts,” Turnquist said.
On the other hand, the Fed’s decision in 1995 to end its aggressive rate hikes and then cut them likely contributed to a 35% market return the year after the last rate hike. But so is a strong economy accelerated by software—based on productivity gains.
In other words, in most of the Fed’s previous decisions, the agency was the “primary driver” of strong market gains, Turnquist said. But sometimes other forces are at work.
This dynamic could affect stocks and your 401(k) plan in the coming months.
What happens when profits decline?
For example, based on recent earnings reports, S&P 500 companies appear to have emerged from a year-long earnings slump (marked by quarterly earnings declines) in the third quarter. This could boost the market.
Detrick said recent strong productivity gains driven by artificial intelligence, which will allow employers to raise wages without raising prices, are also likely to continue.
Is the stock price too high right now?
Meanwhile, the stock is trading at a relatively high forward 12-month price-to-earnings ratio of 18.6 times, above the 10-year average of 17.6, according to Turnquist and FactSet. That puts a greater onus on the economy and earnings to perform well, Turnquist said. If the U.S. hits a moderate or severe recession, markets could take a hit no matter what the Fed does or doesn’t do.
Another thing to keep in mind: The market’s solid gains following the Fed’s decision to stop raising interest rates could also be fueled by subsequent rate cuts. In December 2018, the Federal Reserve raised interest rates for the last time, bringing an 11.7% increase to the market, and the following three and six months increased by 17.7% respectively.
But in August 2019, Fed officials began cutting interest rates, helping the S&P return to 27.9% in the 12 months since the last rate hike.
In the medium term, the Fed’s stay on the sidelines may continue to boost stocks. But according to futures markets, investors expect a rate cut in May or even earlier.
Turnquist said that if the Fed refutes this argument and continues to believe in the “long-term higher” mantra, “the stock market may pull back and give up part of the recovery.”
This article originally appeared in USA Today: The Fed may end raising interest rates.This may trigger your 401(k) plan