December, 2021
During the last FOMC meeting of 2021, the Fed decided to accelerate its tapering process (a reduction in policy support) to end in March 2022 instead of June 2022, to contain inflation pressures in the country. Note that the November figure for US inflation was 6.8%, hitting a new record high since 1982. Most of the members of the institution expect 3 rate hikes by the end of the year, after finishing the QE program launch in march 2020 during the covid pandemic.
In this post, we have tried to look at what happen on the performance of the main US equity index, the S&P 500, in a raising rates environment. We do not aim at predicting accurately the index performance in 2022, but simply having a look at similar historical periods.
We have plotted the actual policy rate in the US since 1956 (blue line) and the corresponding value of the S&P 500 index (green line) during the same period.
The last two decades have, on average, the lowest fed funds rates, with two clear periods where the institution lowered the rate to near 0%: after the 2008 financial crisis and during the global health crisis in 2020. Note that during the recession of 2001, the fed rate was quite low (around 1%) as the country feared the economy was drifting toward deflation.
On the other hand, the rate reached 20% in 1980 while the country was fighting against double digit inflation. This rising price environment started in 1973 when the country disengaged its currency from the gold standard and lasted almost a decade.
From this chart, it seems that stocks can perform well in these periods. From the recent past, we see that the 2004 to 2007 period, where rates went from 1% beginning of 2004 to 5.25% by mid 2007, was a good period for the S&P 500 index, going from 1130$ to 1520$, earning a 34%. From the start of 2014 to mid 2019, the rate went from 0% to 2.4% and the S&P Index gained 64%. But other historical periods show different results. In 1999, the fed started to rise its policy rates. The market first reacted well by earning around 6%, and suddenly fall in 2000 when the dot com bubble bursted.
We have tried to focus on the beginning of the past rising cycles and look for the 12 month SPX performance. In the graph below, the green line is the 12 Month performance of the index starting at the date on the X-axis. In blue, we see the fed policy rate. In red, we have identified beginning of rising cycles.
The first 12 months of the last rising cycle (begging of 2014) showed a 10% performance. The 2004 period showed a 7% performance of the index. As mentioned earlier, during the 1999 hike, the S&P 500 index performed around 6%. On average, of all the past cycles from 1954, the first 12 months of a rising cycle has been solid with a 7.7% rise.
The negative effect on stocks seems to be delayed by a couple years. On average it happens 2 to 3 years after the rising cycle starts. Clearly this cycle could be very different as we are experiencing a very unusual economical period with record inflation figures and diminishing growth rates.
Wall Street banks have a wide range of expectation for the S&P500 in 2022, going from 4400$ at Morgan Stanley to 5200$ at Credit Suisse.
Most of these analysts agree on one thing, the S&P500 should be less bullish than the previous year and volatility should remain a key aspect of the market in the coming year.
In this context, a lot of them expect passive investment to be less interesting and asset allocators might shift their exposure to real assets or absolute return strategies.
