Broker Check

Stocks have given back more than half of the 2023 gains over the past three weeks

March 06, 2023

Stocks have given back more than half of the 2023 gains over the past three weeks, and the reason why is clear:  For the fourth time since this bear market started in early 2022, markets rallied hard on the hope the Fed was close to ending its rate hike campaign, only to have hotter than expected data and not dovish Fed speak dash those hopes and cause a pullback in stocks.  


This repeating pattern is being driven by the over eagerness of investors to take any singular positive comment on rate hikes or any decline in inflation or growth statistics to mean the Fed is close to ending hiking rates. In reality, however, it’s more than likely the Fed will require 1) Consistent trends in the data and 2) Overwhelming proof inflation is falling before it’ll signal a pause or pivot. 


To do that, we’re going to examine the last three rate hike cycles (late 90’s, the mid-2000s, and late 2010s) to find clues about market conditions that caused the Fed to pause or pivot.  Specifically, we’ll examine:


  • Size and duration of the previous hiking cycles (including levels of real interest rates).  
  • Economic growth:  What were the levels of key growth metrics when the Fed ended rate hikes?
  • Inflation:  What were the levels of inflation (and specifically how much did they fall) when the Fed ended rate hikes?
  • Employment:  Where were key employment metrics like jobless claims, the unemployment rate, and others when the Fed finally paused?


Of course, I understand that this hiking cycle is different than previous ones (they are all different).  But the bottom line is reviewing the history of Fed actions can give us better insight into when we might expect the Fed to actually signal it’s “done.” And, I believe this research will provide useful context for the next time the markets and investors get overly optimistic about an imminent pause or pivot.


Bottom line, I remain concerned that the Fed is not nearly as close to ending rate hikes as the market hopes. I don’t think the late 2010’s hikes are a good comparison to now, because it was a different era in inflation.  The terminal rate isn’t as high as it was at previous peaks. Real interest rates aren’t as high as they were at previous peaks. Inflation is higher than it was (meaning more hikes may be needed) The Unemployment rate is lower (meaning more hikes may be needed.


  • Rates need to go higher than the 5.125% expectation. Currently Federal Funds rate is 57%.
  • Currently, terminal Fed Funds expectations is about 5.625%. That’s 100 bps higher than current levels. (1%)
  • That would put the peak Fed funds rate in line with previous cycle highs.
  • Given low unemployment and high inflation, however, rate hikes to 6.00% or higher can’t be ruled out.


So what does this mean for markets? That means growth, tech, and high multiple sectors should remain volatile while value, low multiple, and RSP should outperform over the longer term. Broadly, it also means that any rallies will likely be temporary, because stocks will not be able to bottom until they know when the Fed is “done” with rate hikes (and even that might not be the bottom depending on the economic damage).


That said, the bond market has dramatically re-priced rates over the past month, and the drop in stocks hasn’t been too bad. That resilience, if it lasts, implies the stock market has priced in rate hikes, which could be a powerful positive in the coming months.


So, when will the Fed stop? My thought: 5.375% in June. The Fed is cognizant of previous rate hikes and dis-inflation is occurring. They won’t want to hike much more given past actions. No one at the Fed is materially guiding expectations higher, and as such I see the dots rising only slightly. I continue to expect growth to slow in the coming months, evoking a “wait and see” approach for markets. Our positioning in value stocks and small stocks appears to be the right move for now given the background. We will know better over the next couple of months as to the markets health in the second half of this year. I still expect a pretty good move up, but it depends on the Feds actions over the next few months.

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