Rule #7 Don’t Fight the Fed

This isn’t a trading strategy so much as it is an observation.

The Federal Reserve has a huge impact on the performance of stocks when it changes direction on interest rates.  Between 1946 and 2007, the S&P 500 gained an average of 6.2% during the 12 months after an initial interest rate increase.  Meanwhile, the S&P 500 advanced 15.5% after the first interest rate cut.

As a predictor of market trends, even this indicator is not completely reliable in the short-term.  During the first six months after a rate cut, the S&P 500 advanced only 62% of the time.  However, during the twelve months following a rate cut, prices advanced 85% of the time.

In general, the Fed typically takes more than twice as long to raise rates than to lower them.  Rate increases typically occur over an 18-month period, while rate cuts usually happen over a 7-month period.

The main point that Sam Stovall makes here is that cyclical sectors tend to do better than the rest of the market when interest rates start to decline.  Stovall also recommends rethinking exposure to stocks in general (especially cyclicals) when interest rates rise.

Sectors that have historically outperformed the market after a rate reduction include technology, consumer discretionary, industrials, consumer staples, and health care.

Sectors that have historically outperformed after a rate hike include technology, health care, telecommunications, and energy.    You will note that two of these sectors (technology and health care) have outperformed the S&P during rising and falling interest rate environments.  These seem to represent true growth sectors over the long-term.

If you have been following this blog series, you now know more about sector rotation strategies than most financial advisors.   Research is a continual process, however, and thoughtful investors interested in learning more might consider studying John Murphy’s classic book, Intermarket Analysis.

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One Response to Rule #7 Don’t Fight the Fed

  1. Pingback: The Central Banks Are Buying Gold Like It’s 1965 | Commodity HQ

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