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Written by: Chris Vandiver, CFA, VP, Equity Research | Advisor Asset Management
Many pundits love to come out with bold statements such as, “Typically the stock market bottoms ‘x’ number of days before/after ‘y’” and with all the hype surrounding one of the fastest Fed tightening cycles ever, they are out in force. Just choose if you think the bottom has happened or will happen after the Fed pivots and you can find a pundit to cater to your confirmation bias. So today we want to show that the world is not black and white, and making blanket statements without context is at best an oversimplification, and at worst….
First, let us start by defining what we mean by a “Fed pivot.” A Fed pivot means the Federal Reserve switches from a period of holding or raising the federal funds rate, to lowering/easing the federal funds rate. Now to define our time periods. Since 1954, the U.S. has had 10 full business or economic cycles. We are focusing on the 10 recessions that took place during these 10 economic cycles. Of these 10 recessions, eight of them had a corresponding bear market (in this case a bear market is defined as price decrease of 20% or more for the S&P 500). What we wanted to learn is at what point in each cycle did the market bottom, to find out whether markets bottom before or after a Fed pivot.
Past performance is not indicative of future results.
The incredibly busy chart above, shows the performance of the S&P 500 for all 10 recessions in the year leading up to and after the Fed lowered the federal funds rate (day zero and the grey line in the middle of the chart). The blue vertical arrows represent market bottoms. As you can see, there is great disparity in the returns following a Fed pivot, and the market bottoms are almost evenly split between before and after the pivot. None of that lends itself to easy conclusions, but easy conclusions are exactly what gets reported on the news. Many articles will show a simple average of the data, as in Chart 2 below, and present it as an easily understandable chart for investors to draw conclusions. But such charts are an oversimplification that can mislead investors and cause real damage to their portfolios.
Past performance is not indicative of future results.
So, if it is misleading to say something simple such as, “Markets typically bottom 11 trading days before a Fed pivot,” what can we say about the data? Well, as can be seen below in Table 1, buying when the Fed pivots does usually yield a positive return one, two, and three years out for most easing periods— with the Tech Bubble and Financial Crisis being the exceptions. One can also say the market bottoms after the Fed pivoted in four of the past five times since 1980, as shown in Chart 3. And one can also there is a historical precedent for multiple expansion following a pivot, as shown in Chart 4. We have spoken about how averages can be used to hide the reality behind the data, so we will clarify so as not be hypocritical. Note that price-to-earnings ratios (P/E) cannot be negative, and for indices they are usually quite range bound. The deviations between P/E’s for each period in our data set is minimum enough that we feel confident in saying we are not oversimplifying or obscuring the data. That said, we will point out the one outlying period — the easing period following the Tech Bubble when P/E’s were abnormally high; but again, that period is the exception not the rule.
Past performance is not indicative of future results.
Past performance is not indicative of future results.
Past performance is not indicative of future results.
Key takeaways:
- Following a Fed pivot, the deviation in S&P 500 returns is vast.
- Buying the S&P 500 on the day of a Fed pivot typically yields a positive return one, two, and three years out, except for the periods following the Tech Bubble and Financial Crisis.
- The S&P 500 bottomed after the Fed pivoted in four of the past five easing periods.
- S&P 500’s P/E’s typically bottoms after a Fed pivot.
- For the S&P 500, there is historical precedent of multiple expansion following a Fed pivot.