There is a saying in investing – Don’t Fight the Fed. That is, the Federal Reserve. Its’ origin traces to Marty Zweig’s renowned list of seventeen trading rules, where it clocks in at number six. The idea is the Federal Reserve uses interest rate policy to guide the economy – raising interest rates to increase the cost of capital to slow down the economy or cutting interest rates to decrease the cost of capital to stimulate the economy. Don’t fight the Fed is shorthand for trimming or eliminating stock exposure when the Fed is hiking rates.
It sounds reasonable. I remember hearing a lot of talk about it when the Fed starting hiking interest rates a few years ago… Don’t fight the Fed. Stay away from stocks.
On March 25, 2022, the Federal Reserved hiked interest rates to 0.25%, marking the first rate hike since 2018. That began the swiftest rate hiking cycle in history as interest rates climbed from 0.25% to 5.5% until the first cut on September 18, 2024. The Don’t Fight the Fed folks spent ‘22 and ‘23 warning everyone about stocks (they were quieter in ‘24 for reasons that will become apparent two sentences from now). They lauded the opportunity to earn 5+% “risk-free” in short-term Treasurys. Here is the performance of the S&P 500 and short-term Treasurys from the date of the first rate hike in 2022 to the first rate cut in 2024:[i]
And that’s why the Don’t Fight the Fed folks have been quiet lately…
A quick note on this chart, as some may see appeal in the smooth ride offered by short-term Treasurys depicted by the red line. The objective of investing is to at the very least maintain but more importantly to grow your purchasing power. If you invest funds at 3% per year while prices increase by 4% per year you have lost purchasing power to the tune of 1% annually, which is difficult to construe as anything but total failure. During the period depicted above, inflation rose at 3.81% annually,[ii] so the real (inflation – adjusted) annualized returns for stocks vs. short-term Treasurys comes out to:
- Stocks: +6.85%/yr.
- Short-Term Treasurys: -1.14%/yr.
Certainly something overwhelmingly positive occurred to spur such an advance in equities despite the Fed’s rate hiking cycle? Here’s a sampling of headlines over the period:
- Q1 ’22 and Q2 ’22 printed two consecutive quarters of negative GDP – what many define as a recession
- Longest ever yield curve inversion – an “indicator that has successfully predicted every recession”
- 2022 Bloomberg headline: “Forecast for US Recession Within Year Hits 100%”[iii]
- 2022 mid-term elections
- Worst inflationary episode since the 1970s
- 2022 the worst year for a 60/40 portfolio (60% S&P 500, 40% 10-year Treasury bonds) since 1937
- Regional banking crisis of March ’23 – three of the four largest bank failures ever occurred within a 1.5-month period
- War in Ukraine
- October 7th attack in Israel – tensions in the Middle East reignite
- 2024 presidential election season
- Sahm rule triggered, which has “accurately predicted every past recession”
- Yen carry trade blows up in August 2024 – third largest VIX (volatility gauge) spike on record (the other two were in 2008 and 2020)
So why on Earth did the stock market return +29% despite all that?
As much as the financial media and charlatans masquerading as financial advisors refuse to admit, there is a singular long-term driver of stock prices: earnings. That is, profits. The beautifully simple answer for why the S&P 500 returned +29% during the latest rate hiking cycle amidst those aforementioned calamities is the companies that make up the S&P 500 – the largest, best financed businesses in the United States of America – adapted and continued to grow their profits. The stock market is the financialization of human ingenuity, and human ingenuity is undefeated.
Investors who hung on while corporations adapted have been handsomely rewarded. Those who heeded the advice Don’t Fight the Fed or chose to flee their equity positions because of one the cataclysms referenced above have been punished.
As for the remainder of this year and next… who knows. Anyone making predictions about the short-term direction of stock prices is either a liar or a fool. But there is one assumption that has proven infallible thus far: no matter what happens, companies will find a way to adapt and grow their earnings. If this assumption endures, the stock market will continue its inexorable long-term upward trend. Those who stay invested – amidst bad news cycles and inevitable temporary downturns – will be rewarded. Those who don’t – or who try to jump in and out at opportune times – will be bitterly disappointed.
Don’t Fight the Fed didn’t work. Try Don’t Fight Human Ingenuity next time.
Sean Cawley, CFP®
Neither asset allocation nor diversification guarantee against investment loss. All investments and investment strategies involve risk, including loss of principal.
Content here is for illustrative and educational purposes only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy. Results will vary. Past performance is no indication of future results or success. Market conditions change continuously.
This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.
[i] YCharts, Fundamental Chart, ^SPX, SHY Total Return Level, 03/25/2022 – 09/18/2024.
[ii] YCharts, Fundamental Chart, US Consumer Price Index % Change, 03/25/2022 – 09/18/2024.
[iii]https://www.bloomberg.com/news/articles/2022-10-17/forecast-for-us-recession-within-year-hits-100-in-blow-to-biden