What does the fed funds rate tell us about the future performance of stocks?
Investing after peak rates has been profitable for investors
Heading into the new year, my focus will shift towards providing more market research, stepping away from personal financial advice. Financial advice is something I’m passionate about, but I don’t feel I have much to add to the conversation that isn’t already out there. In 2024, I’m going to try and improve the regularity of this newsletter too. Look forward to ongoing improvements in my approach. Thank you all so much for subscribing and reading this. I hope this is valuable.
Key points:
Investing after the federal funds rate has peaked has been profitable for investors most of the time.
The dot-com bubble and the Great Financial Crisis left a lasting impression on markets as it took longer for those stock markets to recover.
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I’ve already discussed how long tightening cycles last and how long it takes for rates to descend from the peak rate in the cycle. Today, I’ve turned my attention to how the stock market performs after that peak rate. Currently, the market expects the federal reserve to start cutting rates at some point in 2024, and so I’ve looked at how markets perform as we enter into this next phase in monetary police.
I used the same peaks that I discussed in my previous article on the topic. I used the Wilshire 5000 as a proxy for the stock market because I could easily access this data via FRED, and the Wilshire 5000 is a good proxy for the total US stock market.
In the chart above, I've indicated the average cumulative return by month in red, representing the mean of all cumulative returns since 1970. If you had invested in the Wilshire 5000 during any month since 1970, this red line would show the average return you'd have seen over the following 24 months, based on those starting points.
The data indicates that investing post-interest rate peaks often leads to returns above the average. However, the periods following August 2000 and the Great Financial Crisis of 2007-2008 are exceptions, marked by the market's persistent decline. Notably, the interest rate environment from 1994 to 2001 was unique compared to other peaks, with rates remaining high and confined within a narrow range.
In the early 2000s, the economy faced significant challenges from two main events. Initially, the post-1990s economic boom in East Asia slowed down, leading to a global economic challenge. Concurrently, the bursting of the dot-com bubble, coupled with the Federal Reserve's rate hikes to temper this bubble, marked the onset of a mild recession. This recession, which began in March 2001, was relatively less severe compared to its predecessors. However, the situation worsened with the terrorist attacks on September 11th, 2001, which further intensified the economic downturn, adding an external shock to an already fragile economic scenario.
In March 2007, the Great Financial Crisis plunged the economy into a severe recession, characterized by substantial deleveraging and a lengthy recovery. The crisis caused lasting output reductions and brought to light several problems, including the misvaluation of securities, inadequate government regulation, and credit rating agency failures. The stock market faced years of struggle to recover, prompting the central bank to maintain near-zero interest rates for almost a decade to boost market liquidity.
2024 is shaping up to be a good time to be invested in the market.