Liz Ann Sonders shares her perspective on the U.S. stock market and economy in this monthly Market Snapshot video.
Market Snapshot | February 2024
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Market Snapshot | February 2024
Hi everyone, I'm Liz Ann Sonders and this is my February market snapshot. As always, thank you for tuning in. So in this video, I will address the latest Fed meeting, the Fed's decision to push back on a March start to rate cuts, what history says about stock market performance throughout a full Fed cycle and the latest on the relationship between bond yields and stock prices. Now in the statement accompanying the conclusion of the late January FOMC meeting, the prior tightening bias was dropped.
But simultaneously, there was a pushback in terms of the start to rate cuts. Will they, won't they? And the why behind it is generating lots of questions about what does it mean for markets when the Fed has ended a hiking cycle and may soon be embarking on an easing cycle. Well, the answer is more nuanced than many might think.
[High/Low Chart for Running better-than-average … but for Average S&P 500 % change is displayed]
So it's easy to construct a chart showing average performance for the S&P 500 during various phases of a full Fed monetary policy cycle. In fact, shown here is the average associated with the past 14 full-rate cycles, with the zero line referring to the final hike in each cycle.
[High/Low Chart for Current Fed rate hike cycle is displayed]
So, given the Fed's dropping of its tightening bias at the conclusion of its most recent meeting, we are comfortable with what had already been our view that the final rate hike in this cycle was last July.
Here I'm showing how the S&P has done relative to the average, both during the lead in to last July's final hike, and in the six plus months since then. Now after a weak period around the mini banking crisis last year, stocks have obviously staged a pretty remarkable recovery. And that kicked into high gear when longer term bond yields peaked last October, which was about three months after the July hike. Now that comparison is fine, but the analysis should not stop here.
[High/Low Chart for … historical range has been incredibly wide for S&P 500 % change is displayed]
So let's look at this comparison again, but on a different scale. So why a different scale, you ask?
[High/Low Chart for Minimum and Maximum S&P 500 % change is displayed]
Well, that's because the range of historical outcomes is massive. Not only that, 14 prior cycles actually constitute a relatively small sample size. And any time one deals with a small sample size, but an extremely wide range, caution is warranted around analyzing the average. In fact,
essentially, by definition, under those circumstances, none of the individual outcomes actually look like the average, which is why we bristle when we see analyses on this topic using phrases like, I don't know, stocks typically do something or another. It's the “typically” word that makes me bristle. It's why we remind folks of the old adage, “analysis of an average can lead to average analysis.”
[Table for Small sample size of Fed cycles; wide range of outcomes for Final Fed rate hikes is displayed]
Now this table highlights the details associated with those wide ranges shown in the prior chart. It covers various time periods, including S&P performance 6 and 12 months following the final rate hike, historically, the number of days between the final rate hike, and the first subsequent rate cut, performance associated with those pause phases, and finally, performance 6 and 12 months following the initial rate cut in each of these cycles.
[Green and red shading representing best and worst S&P 500 performance, respectively, is displayed]
Now the red and green boxes here highlight the low and high for performance for each distinct phase. So as shown for the 12 months following final rate hikes historically, the performance range was between negative 28% and plus 32%, with eight negative outcomes and six positive. During the pause phases, which again, are in between the final hike and subsequent initial cut,
performance ranged from minus 27% to plus 26% with, get this, seven positive and seven negative periods. Now, in terms of the length of those pause periods, they were as short as less than 60 days, that was in 1929 and 1957, and approached 900 days in 1981. Now, the most negative outcome during the pause period was in 1974. That was because stocks were still reeling from the brutal recession at that time. The best performance, on the other hand, was in 1981 after the Fed, under Paul Volcker, had slayed the inflation dragon.
Now, performance did start to lean more positive once the Fed started to cut rates. The ranges were still wide, but there were only three negative outcomes six months later and only two negative outcomes 12 months later.
Now, the most negative outcome following an initial cut was in the period from 2006 to 2007. And that was, of course, during the lead-in to the global financial crisis. The range of outcomes was often a function of what longer-term bond yields were doing, not just where the Fed was in its policy cycle. That's certainly been the case over the last several months.
[High/Low Chart for Yields/stocks correlation shifting positive? for Rolling 1-year correlation between S&P 500 and 10-year Treasury yield is displayed]
Now, speaking of that, the relationship between bond yields and stock prices, here's an update to a chart we've shown many times over the past year or so. It measures the correlation on a rolling one-year basis between the 10-year Treasury yield and the S&P 500. Now, specifically, we have been focused on whether a new secular era might be upon us, one in which the correlation between changes in bond yields and stock prices remains negative.
[Green shading for “Great Moderation Era” is displayed]
So for much of the past, call it quarter century, bond yields and stock prices were positively correlated, in part because it was a largely disinflationary era. In other words, when bond yields were rising during what is often referred to as the great Moderation Era, it was typically because growth was improving without attendant inflation concerns, a.k.a. great for stocks, but also vice versa. In the aftermath of the pandemic, as you can see, the correlation moved back into negative territory as the Fed was battling a four decade high in inflation.
[Red shading for “Temperamental Era” is displayed]
Now, as we detailed in our 2024 outlook, a sustained negative correlation would be consistent with what we've nicknamed the Temperamental Era, that spanned the three decades or so prior to the Great Moderation Era. During that era, as you can see, the yield stocks relationship was nearly always negative, in part because it was more of an inflationary era, or at least a secular period with more inflation volatility. In other words, in that era, when bond yields were rising, it was often because inflation was rearing its ugly head, a.k.a. a more bearish backdrop for stocks, but also vice versa.
Now, although we continue to think a return to the great moderation era is unlikely for lots of reasons, the negative yields/stocks relationship has faded, which by the way is to the benefit of diversification in terms of going across both stocks and bonds. But I also think the why behind yield moves is coming into sharper focus for equities, not just the moves themselves.
[List of Takeaways is displayed]
So let's sum it all up. The Fed surprised markets, but not us, in pushing back against a start to rate cuts as early as the March FOMC meeting, even though it did drop its tightening bias. Now stocks have moved on Fed rate cut expectations, but since the retreat in bond yields last fall, have bested the average performance of the market around this point in past cycles. So on the surface anyway, that's good news. However, again, with only 14 prior cycles and a massive range of outcomes, we caution about using averages as a playbook for future results. Bond yields have become less acute of a driver of the major equity market averages, but we do expect a lift in volatility throughout the process of gauging the Fed's reaction function, per the start, eventually, of the easing part of this cycle. Thanks as always for tuning in. We really appreciate it.
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