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Does Fed Pivot Mean It's Time To Buy Stocks?

By Lance RobertsStock MarketsAug 05, 2022 03:58PM ET
www.investing.com/analysis/does-us-fed-pivot-means-buy-stocks-200628114
Does Fed Pivot Mean It's Time To Buy Stocks?
By Lance Roberts   |  Aug 05, 2022 03:58PM ET
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TV's Mad Money host Jim Cramer recently stated it will be time to buy stocks when the Fed pivots.

“When the Fed gets out of the way, you have a real window, and you’ve got to jump through it..… When a recession comes, the Fed has the good sense to stop raising rates. And that pause means you’ve got to buy stocks.”

Of course, such sentiment is not surprising given that over the last decade, investors have repeatedly been beaten into submission to buy stocks when the Federal Reserve eases monetary policy. Such was a point we discussed in “Pavlov’s Dogs & The Ringing Of The Bell:”

“Classical conditioning (also known as Pavlovian or respondent conditioning) refers to a learning procedure in which a potent stimulus (e.g. food) is paired with a previously neutral stimulus (e.g. a bell). Pavlov discovered that when the neutral stimulus was introduced, the dogs would begin to salivate in anticipation of the potent stimulus, even though it was not currently present. This learning process results from the psychological “pairing” of the stimuli.”

Ringing The Bell

Pavlov’s experiment is an excellent example of “classical conditioning” concerning investing.

In 2010, then Fed Chair Ben Bernanke introduced the “neutral stimulus” to the financial markets by adding a “third mandate” to the Fed’s responsibilities – the creation of the “wealth effect.”

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose, and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth.

"For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

– Ben Bernanke, Washington Post Op-Ed, November, 2010.

Importantly, for conditioning to work, the “neutral stimulus,” when introduced, must be followed by the “potent stimulus” for the “pairing” to be completed. For investors, each round of “quantitative easing” introduced the “neutral stimulus,” the stock market rose, the “potent stimulus.”

Fed Balance Sheet vs S&P 500
Fed Balance Sheet vs S&P 500

Given the weight of the evidence from the past decade of market performance, it makes sense that stocks should perform better if the Fed “pivots” from monetary tightening.

Here is the problem with Cramer’s statement. It is incorrect.

Fed Pivots And Recessions

Since 2009, the market and economy have responded negatively whenever the Fed moves away from monetary easing. Such is not just a domestic issue, as the European Central Bank, People's Bank Of China and the Bank of Japan have engaged in similar monetary accommodation programs. The last time the Fed began hiking rates and reducing its balance sheet was in 2018. The Fed reversed course just a couple of months later and 20% lower in the financial markets. Then, in 2020, the Fed massively infused markets with liquidity as the economic shutdown rocked the financial markets.

Fed Balance Sheet vs S&P 500
Fed Balance Sheet vs S&P 500

It would seem Cramer is correct that when the Fed pivots, such is the time to buy stocks. Unfortunately, it isn’t as evident as it seems when looking back through time.

As shown below, since the 1960s, the Fed has repeatedly hiked interest rates to combat inflation. Notably, the stock market continues to perform when the Fed is lifting interest rates. Each time, that increase in the stock market, as the Fed was hiking rates, led investors to believe that this time was different. However, the Fed paused or pivoted from monetary accommodation as an economic recession or crisis was realized.

Fed Funds Pivot Periods
Fed Funds Pivot Periods

Lagging Data

Such is the case because the Federal Reserve is operating on lagging data like inflation and employment to dictate monetary policy changes. Since it takes six to nine months for changes to interest rates to work their way through the system, it is too late when the data reflects a policy error.

The following chart of the unemployment rate, recessions and the Fed funds effective rate shows the problem. Currently, the Fed is hiking rates as unemployment remains very low. However, the unemployment rate historically sharply reverses upon the realization of an economic recession as the Fed slashes rates.

Fed Rate Hikes, Unemployment, and Recessions
Fed Rate Hikes, Unemployment, and Recessions

While it may seem logical to “buy stocks” when the Fed makes its initial pivot, history suggests such a call is often an early event. Given the Fed changes direction once it realizes it has made a policy error, the market is generally in the midst of a bear market.

There is another problem with Cramer’s “buy the pivot” call. Given inflation presents a new dynamic not witnessed in 40 years, such suggests the Fed likely won’t pivot any time soon.

The Fed Likely Won’t Pivot Any Time Soon

The Federal Reserve’s sole focus is to bring inflation down to its 2% target rate. Given that inflation is currently running near 9%, the Fed has a lot of work to do. As St. Louis Fed President James Bullard stated this week:

“I think we’ll probably have to be higher for longer in order to get the evidence that we need to see that inflation is actually turning around on all dimensions and in a convincing way coming lower, not just a tick lower here and there.”

There is a lot in that statement. As noted above, as the Fed further tightens monetary policy, such will slow economic and earnings growth. Such will make valuations harder to justify at current levels.

Secondly, the market and credit spreads give the Federal Reserve plenty of room to operate. As we noted previously, when it comes to the financial markets, the Fed’s primary focus is “financial stability.”

Currently, there are no signs of financial stress, much less instability. From the Federal Reserve’s perspective, despite the decline in asset markets in 2022, investors are still 23% higher than at the market’s peak in 2022. Absent a disorderly meltdown; the Fed will remain focused on stocks being still above their pre-crisis peak. As the Bank of America (NYSE:BAC) notes:

“Since in a typical consumption model, households react to sustained changes in prices over a period of three years or so, the Fed is convinced the wealth effect is still positive.”

How The Fed Sees Finanical Conditions
How The Fed Sees Finanical Conditions

Secondly, while credit spreads have risen, they are still well controlled, suggesting that financial stress in the credit markets remains low.

While Cramer, and most investors, are salivating at the idea of a Fed pivot, with little stress in the credit market, the Fed can remain focused on combating inflation.

However, make no mistake, as the Fed continues to hike rates, there is an increasing risk that “orderly” markets rapidly become “disorderly."

Will the Fed “pause” its rate hikes?

That answer is “yes.”

The only questions are: When will it happen? And how fast will the Fed have to reverse course?

What is clear is that the time to buy stocks is not when the Fed pauses, but when the Fed funds rate returns to the zero bound.

Does Fed Pivot Mean It's Time To Buy Stocks?
 

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Does Fed Pivot Mean It's Time To Buy Stocks?

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Comments (14)
Jeff Page
Jeff Page Aug 08, 2022 6:24AM ET
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Confirm momentum shifts whether in a bull or bear market and hop on the train. The market (stock) is not the economy. Another squeeze and FOMO. We'll turn again.
Timochin Khan
Timochin Khan Aug 07, 2022 10:58AM ET
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On bad and good, no news stock market goes up, a lots of printing money and lots of greedy people every where, we loves casinos...Harry up, bet your money now....
Djamshid Bakiev
AMMM Aug 07, 2022 8:38AM ET
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There is nothing new in the article, everyone from fomo gnomes to professional investors are waiting for such a signal from fed to risk on again. All your analysis is worthless until fed decides to swap the policy to dowish. If you listen carefully to Fed members incl their boss, ultimate goal is to slow down inflation, and if you look at the last jobs report, the demand side of inflation and core inflation will still remain elevated. Also, Q2 earnings were below the historical average, although they were not 'as bad as feared'. So there no fundamental reason to risk funds now and think that this rally is sustainable. Imo it is just short lived relief off the recent lows and now, after >10% correction, it is too late to go long.
Roger Pruzansky
Roger Pruzansky Aug 07, 2022 3:33AM ET
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you all keep posting how many people have you even suckers into your scam not that it didn't work at first I'm sure but now your annoyimg and just waste your time as well as mine. go find somewhere else that the base is not wise to the scam
Pwr Strk
Pwr Strk Aug 06, 2022 7:28PM ET
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what pívot? in 2024?
Seamus Hackett
Seamus Hackett Aug 06, 2022 6:09PM ET
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Cramer says buy, so you sell
Kris Jay
Kris Jay Aug 06, 2022 4:37AM ET
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Fed will continue to hike, not a time to get into the market.
gab nea
gab nea Aug 06, 2022 4:37AM ET
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wrong, Cramer wrong too, just look at the chart lol.the market went up till the easing started!
David Beckham
David Beckham Aug 06, 2022 4:37AM ET
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Right agree must buy until easing start since at the moment pretty sure the real problems come out and high enough to sell I think this is the reason why pp rush to buy now before real problem come out and sell it hard
FMGK Blue
FMGK Blue Aug 06, 2022 1:46AM ET
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The FED has repeatedly said they will keep hiking and that priority was to lower inflation pressures. There is no pivot form the FED at all whatsoever. All speakers have been hawkish including the usually mega bear Kashakari. Try to understand the FED speak before writing such articles.
David Beckham
David Beckham Aug 06, 2022 1:46AM ET
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I think no people would think rate hike stop soon it must continue u til next year and stay long but as long as the market show stregth(even not strong) it could go up until real problem comes out it seems market never waits
Fabio falec
falec Aug 06, 2022 1:46AM ET
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David Beckham  I think you have never heard about "Bear Market Rally" aka "Suckers Rally". Do you?
gab nea
gab nea Aug 06, 2022 1:46AM ET
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who said we are in a bear market? really with low unemployment and no credit crisis? which finance school did you go to?
David Beckham
David Beckham Aug 06, 2022 1:46AM ET
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No need to argue what kind like if rally but as long as you know there is rally then just buy and win that’s it since you keep think is bear market and keep trying to short then you keep losing that it
JIM VETTER
JIM VETTER Aug 06, 2022 1:46AM ET
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who says we're in a bear market?? Anyone who can read a chart KNOWS it's a bear market.
David Beckham
David Beckham Aug 06, 2022 12:47AM ET
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That’s why market starts to go up when people think fed will pivot next year it will keep going up until it really starts change then market should be in trouble again
David Beckham
David Beckham Aug 06, 2022 12:44AM ET
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One more thing based on your analysis which means it’s time now to buy stocks since we buy before it pivot and when it pivots then we start to sell again
 
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