Investors and pundits seem to assume that continued rate hikes mean stocks will keep falling—but historically, that's not true.
If Interest Rates Keep Going Up, Will Stocks Keep Going Down?
At the Federal Reserve's September 20-21 meeting, officials voted unanimously to raise the benchmark fed funds rate by 75 basis points to a range between 3% and 3.25%. The rate hike was widely expected, but new projections for where rates would finish the year arguably caught the market by surprise.1
On the day following the Fed meeting, it was revealed that nearly every voting Fed member expected rates to finish 2022 at a range between 4% and 4.5%, which almost explicitly implies sizable rate increases at the November and December policy meetings. Any hope that the Fed may slow the size and pace of rate hikes was dashed, and stocks have endured sharp selling pressure ever since.
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Many investors and market participants are starting to assume that as long as the Fed is hiking rates and upward pressure is being applied to longer-term interest rates (like the 10-year US Treasury bond yield), then stocks will continue to endure selling pressure. Higher bond yields adversely impact the value of future earnings, and they also give investors an alternative to stocks, the thinking goes. In this environment, investors are increasingly seeing bond yields and stock returns are inversely correlated, which makes the outlook for equities pretty bleak in the next 6-12 months.
But this assumption does not line up with what's happened historically. Looking at weekly returns over the past 60+ years, the S&P 500 index and 10-year U.S. Treasury bonds have a correlation of approximately 0 – meaning there is no clear relationship between the two. If stocks and bonds always moved in opposite directions, the correlation between the two would be -1.
As far as the fed funds rate is concerned, we do not have to go back very far in history to find a time when the Federal Reserve was raising interest rates while stocks were also rising. As seen in the chart below, we had Fed tightening during the 2003-2007 bull market and again during the 2009-2020 bull market.
Source: Federal Reserve Bank of St. Louis3
There is a fundamental flaw in thinking that as interest rates go up stocks will go down, and it's this: interest rates are not the only thing influencing business activity, consumer spending, corporate profitability, and the direction of the stock market. That's why throughout history, there are myriad examples of interest rates marching higher while stocks also posted gains – the relationship between the two is not as tight as many are assuming today.
In my view, we will likely see the stock market enter a new bull market while the Federal Reserve is still in tightening mode. To assume that stocks will only start to climb once the Federal Reserve cuts rates or pauses hikes is to assume that stocks move concurrently with economic news and Fed policy, which we know historically has not been the case. Stocks rarely wait for clear signals or good news to rebound.
Bottom Line for Investors
Here's another reason not to wait for the Federal Reserve to cut or pause rate hikes before liking stocks again: Fed projections are almost always wrong.
Remember, it was just one year ago when the Federal Reserve was talking about 'transitory inflation' and signaling to markets that interest rates would remain low for the foreseeable future. Just three months ago, Fed officials were projecting the fed funds rate would finish the year at 3.8%, and today it's up to 4.5%. These forecasts are simply not reliable enough for investors to hang their hats on. What I can say, however, is that stocks historically have rebounded well before there is clarity on the issues of the day, which in this case are inflation, recession, and the path of fed funds. Investors should not wait for these indicators to get better, knowing that stocks won't either.
In the meantime, I recommend that investors prepare their investments for what's to come. To help you get a better look at data that can help you protect your investments through market changes, I am offering all readers our Just-Released October 2022 Stock Market Outlook Report, which contains some of our key forecasts and factors to consider such as:
Sell-Side and Buy-Side Consensus
Zacks Rank August Industry Tables
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2 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion.
4 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion.
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