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November 2022 / VIDEO

Waiting on the Fed?

We believe a constructive economic outlook, in addition to a Fed pivot, would likely be more supportive for financial markets.

Key Insights

  • Each stock market rally this year has fizzled to new market lows, but many investors hope that a Fed pivot could lead to sustained gains.
  • We believe that a shift to a constructive economic outlook, in addition to a Fed pivot, would likely be more supportive for financial markets.

 

Video Transcript

2022 continues to be a difficult year for investors. Each U.S. stock market rally we have seen this year has ultimately ended in disappointment, and the market has resumed its painful march downward to new lows. This has many investors wondering what it will take for the stock market to stage a sustained rally.

One potential answer to that question is the Fed. Because the stock market’s plummet has coincided with the U.S. Federal Reserve Bank raising interest rates, many investors believe that the market will begin a sustainable rally once the Fed has stopped hiking rates and started cutting rates, which is often referred to as a “Fed pivot.”

As Mark Twain once famously said: “History doesn’t repeat itself, but it does often rhyme.” So in order to test the Fed pivot theory, we can examine prior periods where the Fed has stopped hiking and started cutting.

When we do this, we can see that there have been eight such instances of Fed pivots since 1970, and the results have been very mixed. In three of those instances, the stock market has, in fact, staged a sustained rally after the Fed pivot. But there have also been three instances where the stock market has done quite the opposite.

This begs an important question: What was the difference between these two opposing clusters of results? And an examination of these periods yields one very notable difference: recession. Simply put, when Fed hikes caused the U.S. economy to slow sharply enough that it entered recession, the stock market did very poorly even after the Fed pivot. However, when those hikes did not lead to a recession—an outcome known as a “soft landing”—the stock market performed very well after the Fed pivot.

Two very notable examples of the Fed pivot not helping the market are in the early 1970s when CPI inflation increased all the way to 12% and in the late 2000s prior to the global financial crisis. In both of these cases, the stock market did not rally until the U.S. economy appeared poised to rebound from recession. Essentially, the market required an economic pivot in addition to the Fed pivot.

Meanwhile, Fed pivots in the mid-1980s and mid-1990s were accompanied by strong periods of stock market performance, as the U.S. economy—which had been showing signs of weakness—ultimately remained healthy enough to avoid recession.

In conclusion, while it is not possible to know where the stock market is headed next, history would suggest that the likely cure for the current market woes is not simply a Fed pivot. Ultimately, what may matter most is a pivot to a more constructive economic outlook, in addition to a change in direction from the Fed.

As a result, T. Rowe Price’s Asset Allocation Committee is maintaining a more cautious-than-normal approach to asset allocation positioning. As of October 31, 2022, the AAC holds a tactical underweight to stocks relative to bonds.

Figure 1:

Waiting on the Fed?

waiting-on-the-fed-apac

Past performance is not a reliable indicator of future performance.

Sources: S&P indices. See Additional Disclosures.

Figure 2:

What happened when the Fed pivoted*? 

waiting-on-the-fed-apac

January 1970 to September 2022

Past performance is not a reliable indicator of future performance. Results for other time periods may differ.

Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. S&P Indices and Bloomberg Finance, L.P. See Additional Disclosures.

* The Fed pivot is determined to have occurred in the month where Fed funds target rate decreases from the highest rate recorded in a two-year period, with at least 100 basis points of rate increases.

Figure 3:

Examples where rate hikes led to recession

waiting-on-the-fed-apac

Past performance is not a reliable indicator of future performance.

Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. National Bureau of Economic Research (NBER), S&P indices, and
Bloomberg Finance, L.P. See Additional Disclosures.

Figure 4:

Examples where a recession was avoided

waiting-on-the-fed-apac

Past performance is not a reliable indicator of future performance.

Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. NBER, S&P indices, and Bloomberg Finance, L.P. See Additional
Disclosures.

 

Additional Disclosures

The S&P 500 Index is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and has been licensed for use by T. Rowe Price.  Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); T. Rowe Price's Products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.

IMPORTANT INFORMATION

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.  

It is not intended for distribution to retail investors in any jurisdiction.

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