Don't Fight the Fed: Interest Rates and their Impact on the Stock Market
by Sam Stovall
I have frequently been asked, “What is the one thing an investor should monitor in order to gauge the health of the economy and the direction of the stock market?”
My response is “interest rates.” The mandate of the Federal Reserve is twofold: to promote economic growth and to keep inflation under control.
In this article
- Interest Rates and Earnings
- Substitutes and Present Values
- Returns After Rate Changes
- Long Term: Don’t Fight the Fed
- Digging a Little Deeper
- Cyclicals Lead the Way
- Surprising Strength
- Weeding Out the Weaklings
- Higher Rates = Lower Advances
- Sector Standouts and Slackers
- Why Tech Was on Top
- Where Things Stand Today
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Think of it this way. If the economy were a car, the Fed’s responsibility as a driver would be to maintain a safe speed. If the Fed wanted to speed things up, then they would step on the gas by lowering interest rates. To slow things down, however, the Fed would need to tap or even slam on the brakes by raising interest rates and reducing the availability of capital.
The biggest challenge for the Fed is that our economy isn’t a little red sports car that reacts nimbly to the application of the gas pedal or the brakes. Instead, the economy is more like a supertanker whose response time is remarkably slow. It usually takes between six and 12 months for the economy to feel the stimulation effects of lower rates. It also takes quite some time for the economy to slow down as a result of higher rates.
In the current market environment, the equity market’s response time has been even slower than normal, despite the Fed’s rate reductions and unprecedented stimulative actions.
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