Despite recent claims, the Federal Reserve’s recent decision not to raise rates after ten consecutive increases is unlikely to have any significant impact on U.S. stock market investors. This decision is what many are referring to as a “pause,” with the expectation being that the Fed will resume raising rates at its next meeting in July.
However, analysis of past Fed pauses reveals that claims of significant impacts on the equity market are unfounded. While my conclusions are tentative due to the lack of a clear definition of what constitutes a pause, I focused on rate-hike cycles since 1990 during which the Fed went from raising rates at every meeting to waiting two before continuing to do so. This definition resulted in six past pauses.
Importantly, it is impossible to identify such pauses in real-time; investors can only know for sure that there has been a pause once the Fed resumes raising rates at a subsequent meeting.
In summary, while there is ongoing speculation about the significance of the current Fed pause on U.S. stocks, historical evidence suggests that its impact may be overstated.
The Unpredictability of the Stock Market in Response to Fed Actions
Despite many studies and extensive research, there is little to no consistent pattern to how the stock market behaves in the wake of pauses in the Federal Reserve’s actions. The market has seen rises over periods of a month, quarter, six months, or year after these pauses, but there have also been times where there was no significant shift. Ultimately, the stock market’s average return during these periods was not statistically different than other times.
It can be challenging to make a profitable forecast based on this data alone. As we have seen recently, the U.S. stock market rose after the Fed’s meeting only to decline shortly after.
The Impact on Corporate Earnings
One argument states that the stock market should be higher today because of the Fed pause based on a discounted cash flow model. Using the Fed funds rate to discount future earnings and dividends suggests that stocks are worth more than if the Fed raised rates a quarter point at its June meeting to reach a 5.50% rate. While this may seem like a logical conclusion, it’s important to approach the market with a level head and not rely on just one factor to make investment decisions.
Delay in Raising Interest Rates Does Not Make Much Difference
According to John Graham, a professor at Duke University’s Fuqua School of Business, the recent increase in interest rates does not have any significant impact. Even a month’s delay in raising interest rates does not make even a minuscule difference to the discounted value of a company’s future earnings and dividends. The present value of 20 years of earnings and dividends discounted at 5.5% does not differ much when compared to 19 years and 11 months at 5.5% and one month at 5.25%.
Capital Allocation Decisions
Graham added that a one-month delay in hiking the Fed funds rate to 5.5% is less likely to cause a corporation to make different capital allocation decisions than it would have otherwise. The director of the Duke/CFO Global Business Survey, based on responses to the survey, indicates that it is extremely unlikely.
The Fed’s Pause Has Little Significance
The bottom line is that the Fed’s pause carries little significance. The obsession with it in the financial media is merely a lot of sound and fury signifying nothing.
More: Powell tells Congress to expect higher interest rates.
Dig Deeper: Analyzing Stock-Market Rally Strength
As the stock market oscillates, many investors are looking for clues to determine if the recent rally has staying power. While the S&P 500 may continue to experience fluctuations, there are key indicators that can provide insight into the strength of the current market upswing.
Here are several metrics and factors you should pay close attention to when evaluating the stock-market rally:
Corporate Earnings Reports
Strong corporate earnings reports can provide a positive outlook for investors. Companies exceeding earnings projections can see an increase in stock prices as investors gain confidence in their future growth prospects.
Economic Data
Healthy economic data, such as low unemployment rates and strong GDP growth, can bolster investor confidence and lead to sustained stock-market growth.
Interest Rates
Low interest rates can result in increased borrowing and spending by consumers and businesses, which can further stimulate economic growth and benefit stocks.
Market Breadth
It’s crucial to look beyond overall market indexes, like the S&P 500, to gauge market breadth. Examining key industry sectors and individual stocks can provide a more detailed picture of market strength and potential opportunities.
By analyzing these metrics and staying informed on major market events and news, investors can better assess the staying power of the current stock-market rally.
