Note: view my video on this topic here.
Stocks are down and the Fed is expected to hike rates for the first time in years. Many are worried that we are heading straight for a bear market.
Which begs the following question: has there ever been a 20% stock market decline in advance of or shortly after the first Fed rate hike of a cycle?
Let’s take a look back at recent history…
1) December 2015 Hike
In December 2015, we were in a bull market, and the Fed hiked rates for the first time since 2006. The move: a 0.25% increase (from 0%-0.25% to 0.25%-0.50%).
While stocks would decline in early 2016, they quickly recovered and the Fed would go on to hike rates 6 more times before the S&P 500 peaked in September 2018 (at a Fed Funds Rate of 2.00%-2.25%). The S&P 500 gained 49.6% over that time.
2) June 2004 Hike
In June 2004, we were in a bull market, and the Fed hiked rates for the first time since 2000. The move: a 0.25% increase from 1.00% to 1.25%.
While stocks would have a minor pullback over the next two months, they quickly recovered and the Fed would go on to hike rates 16 more times before the S&P 500 peaked in October 2007. The S&P 500 gained 45.8% over that time.
3) June 1999 Hike
In June 1999, we were in a bull market, and the Fed hiked rates for the first time since 1997. The move: a 0.25% increase to 5.00%.
Stocks would trade sideways to down over the next few months but then recovered and the Fed would hike rates 4 more times before the ultimate peak in March 2000. The S&P 500 gained 12.2% over that time while the Nasdaq 100 gained 105% (the last surge higher during the dot-com bubble was concentrated in tech stocks).
4) February 1994 Hike
In February 1994, we were in a bull market, and the Fed hiked rates for the first time since 1989. The move: a 0.25% increase to 3.25%.
Stocks would trade sideways for the remainder of the year but would go on to have one of their greatest runs in history. The Fed would hike 7 more times (to 5.50%) and stocks would gain 179% before the S&P 500 peaked in July 1998.
The point of looking back at history is not to say the same thing will happen today. It most certainly won’t because every time is different. Case in point: the near 0% Fed Funds Rate today (lowest ever) coupled with a 7.5% inflation rate (highest in 40 years) and 4% unemployment (well below the historical average).
This is something we have never seen before, so why should we expect the future to look the same as the past?
We shouldn’t. But after going through the examples of prior rate hike cycles, one should at least be aware that many different outcomes are possible. We could be on our way to a bear market or the bull market could continue for some time in spite of a rate hike(s), as we saw in 1994 (4 more years), 1999 (9 more months), 2004 (3 more years), and 2015 (3 more years).
From a fundamental standpoint, it seems unlikely that a single rate hike off of 0% would be enough to cause an economic contraction, just as it wasn’t enough back in December 2015 (though many expressed similar concerns at the time). Even at 4 rate hikes, monetary policy would still be very easy in any historical context (real Fed Funds Rate would still be negative even if the inflation rate falls back to 2%).
I don’t know how many times the Fed will hike rates this year. Nobody does, not even the Fed, because it’s dependent on a multitude of factors (path of inflation, unemployment, markets, etc.) that are not known today.
But I do know based on history that you should actually want to see a rate hike in March. For if the Fed cannot hike rates off of 0% with a 4% unemployment rate and 7.5% inflation that means there are much bigger problems out there.
As for the notion that rate cuts are always preferable to hikes, we don’t have to go back very far to disprove this misconception. During last two major bear market, the Fed was cutting rates nearly the entire way down, and that did not prevent deep stock market declines (50+%) and recessions. If you’re still hoping that the Fed won’t hike rates this year, be careful what you wish for, because that scenario would likely mean that the economy and the markets are in a very bad place.
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