Asset Allocation Video

Markets May Need More Than a Fed Pivot to Cure Woes
Tim Murray, CFA Capital Markets Strategist, Multi‑Asset Division

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.

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.

Investors have been disappointed this year as financial markets have reversed course after each rally and resumed a painful march downward to new lows (Figure 1). Overall, market sell‑offs have primarily coincided with the U.S. Federal Reserve’s decisions to raise interest rates, and many believe that a sustainable rally could ensue once the Fed stops hiking and starts cutting rates, typically known as a Fed pivot.

Since 1970, there have been eight instances when the Fed shifted from a hawkish to a more dovish policy stance, and stock market performance after these policy shifts has been mixed (Figure 2). Fed pivots in the mid‑1980s and mid‑1990s were accompanied by market gains as the economy remained strong enough, despite some signs of weakness, to avoid a recession. 

So Far, Markets Have Fizzled After Each Rally

(Fig. 1) Periods of positive returns have been short‑lived, with pullbacks to new market lows

Periods of positive returns have been short‑lived, with pullbacks to new market lows

Past performance is not a reliable indicator of future performance.
Year‑to‑date as of October 25, 2022.
Sources: S&P indices. See Additional Disclosures.

Historical Fed Pivots* Have Yielded Mixed Results

(Fig. 2) When Fed hikes caused a recession, a sustained stock market rally was unlikely

When Fed hikes caused a recession, a sustained stock market rally was unlikely

Past performance is not a reliable indicator of future performance. Results for other time periods may differ.
January 1970 to September 2022. Shows S&P 500 performance around initial fed funds rate cut.
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 the Fed funds target rate decreases from the highest rate recorded in a 2‑year period, with at least 100 basis points of rate increases. One basis point equals .01%.

Meanwhile, shifts in monetary policy did not help financial markets prior to the global financial crisis in the late 2000s or in the early 1970s, when inflation measured by the widely used consumer price index surged to 12%. In these instances, the stock market did not rally until the economy was poised for a rebound from recession. 

Notably, our analysis showed that when Fed hikes caused a sharp slowdown in economic activity that led to a recession, financial markets performed poorly, even after a Fed pivot. However, when the rate hikes did not cause a recession—often referred to as a “soft landing”—stock markets rallied after the pivot.

In our view, a Fed pivot may not be the cure for the current market woes. Ultimately, we believe a shift to a more constructive global economic outlook, in addition to a change in monetary policy, would likely be more supportive for financial markets. As a result, our Asset Allocation Committee remains cautious and is maintaining an underweight allocation to stocks relative to bonds.

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Additional Disclosure

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 provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of November 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual future outcomes may differ materially from any forward-looking statements made.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Fixed‑income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. All charts and tables are shown for illustrative purposes only.

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© 2022 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.


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