The stock market usually performs well once the Federal Reserve is done raising interest rates, but that rally might have to wait.
The central bank has been lifting rates since last year to cool inflation by reducing economic demand, causing worries it could trigger a recession. But the rate of inflation has been declining, signifying that the end of rate increases may be near.
That optimism has powered the
to an almost 15% gain from its early October low point, and the
is up just over 15% in that time. Many fast-growing technology stocks are valued on the basis that a bulk of their profits will come many years in the future—and future profits become more valuable when rates go down.
More gains could be on the way when the Fed does pause. The S&P 500’s median move in the six months after the Fed’s final rate increase in hiking cycles dating back to 1990 is up 13%, according to RBC. In other time periods, that gain is less, but a gain nonetheless.
Since 1995, the S&P 500 technology sector performs the best under these circumstances, with median returns of up 19%, according to RBC. So if the market keeps trading the way it has, then a Fed pause would unlock more Nasdaq, or tech, outperformance.
The problem is that the Fed may not be close to the end of its rate hikes. First off, the January jobs report was hotter than expected, which means inflation might not decline quickly enough for the central bank to pause soon. Secondly, Fed Chairman Jerome Powell said last week that more rate hikes are likely necessary.
Combine that with the fact that stocks are not exactly cheap, and it seems that the market could be in for a rough road ahead until the Fed finally stops increasing rates. Stock valuations remain at historically high levels, given the level of interest rates on risk-free bonds. Plus, there is added risk to economic activity and earnings if rates move higher.
That is why the S&P 500 has run into “resistance.” At roughly the 4100 level, it is having trouble moving higher from here. Sellers have come in at this level consistently over the past several months, as the Fed and economic outlook hasn’t improved enough.
Things in the stock market might just have to get worse before they get better.
Write to Jacob Sonenshine at firstname.lastname@example.org