Mitch on the Markets

September 5th, 2022

Fed’s Actions are Just One Factor That Moves Stocks

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Last week, Federal Reserve Chairman Jerome Powell gave a speech in Jackson Hole that lasted under ten minutes and, as far as I could tell, included no new information. Powell reiterated the Fed’s hawkish approach to inflation, stating the central bank would maintain “a restrictive policy stance for some time.” His comments were a repeat of what the Fed has been saying for months, but the market sold off sharply anyway1.

Market consternation was tied to his statement that the Fed would “keep at [rate hikes and tightening] until we are confident the job is done.” The market took this as a clear sign that this Fed would likely keep tightening even if the economy entered a recession, much like the Volcker Fed did in the 1980s to fight inflation. Post-Volcker, bond traders have come to expect that the Fed would rush to cut rates and loosen monetary policy any time the economy showed a hint of weakening, which is often referred to as the “Fed put.” Chairman Powell seemed to be putting that assumption to rest.

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In a sense, the market set itself up for this moment. By early August, interest-rate derivatives like overnight index swaps were predicting a fed funds rate at 3.3% by the end of 2022, with the same indicators forecasting rate cuts – yes, cuts – by the summer of 2023. These rosy projections ultimately pegged the fed funds rate at 2.5% by 2024, a source of optimism that arguably drove some of the market rallies over the last few weeks. Minneapolis Fed President Neel Kashkari put it best when he said “there’s a disconnect between me and markets,” explicitly adding that rate cuts by next summer were not realistic.3 With Chairman Powell setting the record straight last week, the equity markets have been enduring selling pressure since.

There is no doubt the market is sensitive to Fed policy decisions, particularly since the inflation issue means rate hikes and more monetary tightening are firmly on the table. But I think we’ve reached a point where many investors see the entire fate of the stock market as resting in the Fed’s hands, which I think short-changes other – arguably more important – factors that drive stocks.

The most important factor is corporate earnings. From 2000 to 2010 – which readers should note was a decade bookended by big recessions and bear markets – the earnings growth rate for S&P 500 companies was a meager +6.0%, while the total return for the S&P 500 was -9.0%. From 2010 to 2020, however, earnings growth for S&P 500 companies was +174%, while the S&P 500 returned +252%. While not perfect, this relationship between earnings and stock market returns exists throughout history.

Over the past 80+ years, for example, the S&P 500 has generated approximately 11% in annualized returns while corporate earnings have grown at about a 6% rate. This relationship implies that corporate earnings make up a bulk of total stock market returns, with the remainder coming from dividends and multiple expansions. I’ll concede that the Fed undoubtedly plays a part in influencing the long-term profit landscape for businesses and spending power for consumers – which ultimately affects earnings – but framing the central bank as the primary driver of earnings and stock market returns is incorrect, in my view.

When an investor buys a stock, they are buying a share of that company’s future earnings, and they are also investing in the business’s innovative abilities, management, competitive advantages, and ability to invest, hire, and grow. In the short-term, a company’s share price will wobble with shifts in sentiment and, in the current environment, with changing expectations about inflation and interest rates. Over the long-term, though, the price of the stock should ultimately reflect a company’s performance and its ability to grow earnings, which may be impacted by the Fed but not determined by it.

Bottom Line for Investors

It appears we have entered a period where many market participants see the stock market as fully dependent on the Federal Reserve, which has led to forecasts about what the Fed will do and a fixation on every word uttered by Fed governors and Chairman Powell. While I certainly agree that Fed policy can and will affect economic activity down the road, the siloed view that Fed policy will ‘make or break’ markets seem overcommitted to the idea that interest rates are the only thing that matters over the next year or two. What about earnings, economic growth, geopolitics, sentiment, and global economic trends?

To help you focus on additional factors like these that are impacting the market, I am offering all readers our Just-Released September 2022 Stock Market Outlook4, which contains some of our key forecasts and factors to consider such as:

And much 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

1 A Wealth of Common Sense. 2022. https://awealthofcommonsense.com/2021/06/the-stock-market-vs-earnings-growth/

2 Zacks Investment Management reserves the right to amend the terms or rescind the free-Market Strategy Report offer at any time and for any reason at its discretion.

3 Wall Street Journal. August 19, 2022. https://www.wsj.com/podcasts/google-news-update/why-wall-street-and-the-fed-have-been-at-odds-lately/1aa77e88-07f3-4f5f-8317-0e97871ec2e7

4 Zacks Investment Management reserves the right to amend the terms or rescind the free-Market Strategy Report offer at any time and for any reason at its discretion.

DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

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