The easy monetary policies that boosted markets in 2020 and 2021 went away in 2022, with the Federal Reserve shifting from quantitative easing (QE) to quantitative tightening (QT) alongside aggressive rate hikes. Equity markets seemed to be highly responsive to Fed actions, with U.S. stocks rallying during the easy money years and declining for most of 2022 as financial conditions tightened. The “don’t fight the Fed” mantra served as a straightforward explanation for market action.
But then Q4 2022 and January 2023 happened.
In the fourth quarter, the Federal Reserve raised the benchmark fed funds rate by 75 basis points at the November meeting and by 50 basis points at the December meeting – very hawkish by historical standards. One might have expected stocks to tumble as rates kept moving higher, but they didn’t – the S&P 500 rallied by +7.4% in the three months ending December 31, 2022.
Stop Waiting on the Sidelines, It’s Time to Focus on Fundamentals!
In the current environment, many investors want to remain cautious until the Fed officially confirms it is pausing rate hikes, but I think by then it will be too late. The stock market is not likely to wait for confirmation, and I do not think investors should either.
Instead of waiting on the sidelines, I am offering all readers our just-released Stock Market Outlook report, which contains some of our key forecasts to consider such as:
- Setting U.S. return expectations for 2023
- Zacks forecasts at a glance
- What produces 2023 optimism?
- What’s alive for 2023 pessimists?
- Is it time to buy stocks?
- And more…
If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!
IT’S FREE. Download the Just-Released February 2023 Stock Market Outlook1
In January, the Fed again raised rates by 25 basis points and signaled that more hikes were coming. But the S&P 500 added another +6.18%, and U.S. small- and mid-cap stocks fared even better for the month, both rallying north of +9% as ‘risk-on’ sentiment came back into play.
In all, stocks went up close to +15% in a four-month period, while the benchmark fed funds rate rose by a stout 1.5%, and financial conditions tightened further.
The argument I’m making here is not to throw cold water on the “don’t fight the Fed” mantra. Lower interest rates increase the value of forward earnings; make capital more accessible for consumption and investing; and help drive credit, loan and economic activity. That’s good for the economy and generally great for stocks.
Tighter financial conditions and higher rates tend to work the other way, which can change investor sentiment towards risk assets and lower the multiples they’re willing to pay for them – a phenomenon we saw play out in 2022.
I agree that “don’t fight the Fed” is a useful tool in determining fundamental views of the economy and markets, but it’s also true that interest rates are not the only thing influencing business activity, consumer spending, corporate profitability, and the direction of the stock market. That’s why throughout history, there are myriad examples of interest rates marching higher while stocks also posted gains. The narrative today is basically that the Fed controls the fate of the stock market, but I do not think the relationship between the two is as tight as many are assuming.
We do not have to go back very far in history to find a time when the Federal Reserve was raising interest rates and tightening financial conditions while stocks were also rising. As seen in the chart below, there was Fed hiking during the 2003-2007 bull market and again during the 2009-2020 bull market. Stocks and the economy performed very well in these periods, and ‘don’t fight the Fed didn’tplay out.
In the current environment, I’m seeing that many investors are preferring to wait until the Fed hits the pause button on rate hikes before turning bullish again. But to assume that stocks will only start to climb once the Federal Reserve cuts rates or pauses hikes is to assume that stocks move concurrently with economic news and Fed policy, which we know historically has not been the case.
Stocks are discounters of future economic and earnings conditions, which means they rarely wait for clear signals of good news to rebound. The past four months make this clear.
Bottom Line for Investors
There’s an argument that the market rally over the past four months has been in anticipation of the Fed nearing the end of the tightening cycle – a fair point. But the fact remains that stocks have rallied as fed funds have moved significantly higher, and as the Fed positions for another two, maybe three rate hikes well into the spring. Investors can hang onto “don’t fight the Fed” and remain cautious until the Fed officially confirms it is pausing rate hikes, but I think by then it will be too late. The stock market is not likely to wait for confirmation, and I don’t think investors should either.
Instead of cautiously waiting for confirmation, I recommend that investors use the fundamentals to help guide their investing decisions. I am offering our Just-Released February 2023 Stock Market Outlook Report, which will provide you with key forecasts along with additional factors to consider, such as:
- Setting U.S. return expectations for 2023
- Zacks forecasts at a glance
- What produces 2023 optimism?
- What’s alive for 2023 pessimists?
- Is it time to buy stocks?
- And more…
If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!
Disclosure
2 Fred Economic Data. February 7, 2023. https://fred.stlouisfed.org/series/DFF#
3 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion.
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