OPINION: There is no easy, straightforward or mechanical way in which you can use changes to the Fed funds rate to time the stock market, Mark Hulbert writes.
How should stock market investors react when the U.S. Federal Reserve begins to raise the Federal Funds rate? That question, in one form or another, is being asked by almost all investors these days. While no one knows for sure when the Fed’s rate hike cycle will begin, it could happen soon —perhaps by the end of the year. With the Fed funds rate near zero and the U.S. economy growing, the question is when, not if.
I reached this conclusion upon analyzing all rate hike increases and decreases announced by the Federal Reserve’s Open Market Committee dating back to 1990. For each rate change decision I calculated the S&P 500’s total return from the date of the increase, either over the subsequent 12 months or until the date of the FOMC’s next rate change decision, whichever came first. The results are summarized in the table below.
Other tools in the Fed tool chest There are two other big reasons why the stock market doesn’t react to rate hikes in the way conventional wisdom would suggest. The first is that the Federal Reserve in recent years has become increasingly transparent, telegraphing to the markets well in advance about when it may change the Fed funds rate. This means that the stock market will have had plenty of time to react by the time a rate hike actually occurs.
The other reason the stock market doesn’t always react in predictable ways to rate hike decisions: The Fed in recent years has increasingly relied on large-scale asset purchases in addition to changing the Fed funds rate —otherwise known as quantitative easing .
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