The Fed Giveth, The Fed Taketh Away

With the stock market tanking and the Federal Reserve finally starting to raise interest rates and reduce its $9 trillion balance sheet, it's probably a good time to look back and determine how much of the stock market's gains in the past 12 years or so have been built on extremely accommodative Fed monetary policy. That could provide some idea of how much we can expect the market to drop once the Fed has finally stopped the tightening process, and when stocks might start rising again.

Since reaching its all-time high of 16,057 back on November 15, the NASDAQ had dropped nearly 29% as of May 18, when it closed at 11,418. Likewise, the S&P 500 is down nearly 18% since it hit its all-time high on December 27, while the Dow is off more than 13% after reaching its peak on that same day.

Those declines followed several indications from Fed Chair Jerome Powell and other Fed officials that the central bank had finally conceded that inflation wasn't "transitory" after all and that it had to act aggressively before inflation got totally out of control.

The Fed raised its benchmark interest rate by 25 basis points on March 16, its first rate increase since December 2018, and another 50 bps on May 4, its largest increase since May 2000. The Fed's next meeting is scheduled for the middle of next month, at which it is expected to vote for another 50-bp hike, followed by several more by the end of the year. If the Fed raises rates by 50 bps at each of its next five meetings, including the one right before Election Day, that will push its benchmark rate to about 3.5%, its highest level since January 2008. That was just before the onset of the global financial crisis and the Great Recession.

Then began an unprecedented series of Fed rate cuts and massive asset purchases that, with a few pauses in 2017 and 2018, have continued until now. They have helped boost stock prices to record levels, even though U.S. economic performance during most of that time was generally considered to be subpar, and we suffered through a global pandemic that shut down major parts of the economy for long periods.

So it's probably valid to ask how much of the stock market's rise since 2008 has been due to accommodative Fed monetary policy and how much to good old-fashioned fundamentals, like corporate earnings. In other words, how deep can we expect stock prices to drop once the Fed is done with this tightening process?

Looking at the S&P 500 chart, the index is now back down to about where it was about a year ago, meaning that all of the gains from the past year have disappeared. The NASDAQ's drop has been even more severe; it's back to where it was in the fall of 2020. So the question is: How far can we reasonably expect stocks to fall before all of the Fed's irrationally exuberant monetary policy has wrung itself out of the system, and stocks can then begin to rise again? I.e., how will we know when we've hit bottom?

Is it reasonable to say that the Fed was responsible for half of the stock market's gains since March 2009, which is generally considered the stock market bottom during the Great Recession? If so, boys and girls, we've got a long way to go before we hit bottom this time.

On March 2, 2009, the S&P 500 registered 683, after which it began a nearly 12-year climb upward that, with a few minor corrections along the way, basically wouldn't end until February 2020, when the first signs emerged of what would become the Covid-19 pandemic. From February 2020 to March 16, the S&P would plunge nearly 32%, after which it was rescued by the Fed, which quickly cut interest rates back to zero and increased its balance sheet to nearly $9 trillion. The S&P then more than doubled by December 2021, when the markets finally came to the realization that the Fed-sponsored party was over.

So, to recap, between the March 2009 bottom of 683 and December 27, 2021, top of 4,766, the S&P 500 gained nearly 600%, not including dividends. That neatly tracks the Fed's monetary stimulus programs dating back to the Great Recession. If we say the Fed was responsible for half of that gain, that will put the S&P back to about 2,700 after the removal of the Fed stimulus. Since the S&P 500 is now at about 3,900, that would indicate we might expect another 1,000 point drop in the index, putting it back to where it was about two years ago. Is it unrealistic to think that we have about two years' worth of Fed froth to wring out of the market?

I'm not predicting that, but I don't think it's unreasonable to think it could happen. So if you're looking for an opportunity to jump back into the market, you have time.

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George Yacik Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.

One thought on “The Fed Giveth, The Fed Taketh Away

  1. Yes, it is reasonable to assume we have a good bit more down side this year. So beware the false rally.

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