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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Friday, June 11, 2021

Even amid Fed rate hikes, stocks usually go up

Rampant inflation in an overheating economy is bad. And so to fight that or prevent that, the Federal Reserve is expected to tighten monetary policy via the tapering of its quantitative easing program and the hiking of its fed funds rate.

Currently, employment is rising and the prices of goods and services are climbing. But it's hard to argue that the economy is overheating with employment still 7.6 million jobs below pre-pandemic levels. And it's hard to argue that inflation is rampant as the increase in prices largely appears to be related "transitory" factors like base effects, reopening quirks, and some unusual short-term supply chain bottlenecks.

Nevertheless, with the consumer price index (CPI) jumping a hotter-than-expected 5.0% year-over-year in May — the biggest jump since August 2008 — it's worth exploring what tighter monetary policy could mean for investors.

Credit Suisse's Jonathan Golub did just that earlier this week, and he found that tighter policy isn't obviously bad for stocks as investors might expect.

"While investors might interpret the reversal of Fed policy as a bad omen, history shows that stock returns remain robust in the months leading up to and following the first rate hike," Golub said in a note to clients on Wednesday. "More specifically, over the past four rate hike cycles (’94, ’99, ’04, ’15) the S&P 500 gained 9.5% in the 12 months prior to the first hike, and 26.0% over the subsequent three years."

Stocks tend to go up. (Credit Suisse)
Stocks tend to go up. (Credit Suisse) (Yahoo Finance)

"The real damage from higher rates tends to occur later in the cycle when tighter policy flattens/inverts the curve," he added. "We are eons away from that happening."

Now, we'll acknowledge that the average Golub computed is arguably an oversimplification and that four rate hike cycles is a pretty small sample size.

And when you consider all the other variables in the market, you could also argue that what we're experiencing today is totally unprecedented. And so, the past won't help outline the future.

But we can't help but appreciate the "stocks usually go up" energy emanating from Golub's chart. And to that, we'd make two points.

First, everyone is already talking about the risk of inflation heating up. And so the downside of tighter monetary policy amid rising prices is an event that may already be priced into the market.

Second, businesses can be very flexible in the pursuit to grow profits. This means that when they are confronted by challenges that threaten profit growth, they will make changes to their strategies or even outright overhaul their business models. This is something we learned throughout the coronavirus pandemic. Offices had employees working remotely. Restaurants ramped up their pickup and delivery options. TV personalities broadcast from their homes. And so on.

All this speaks to the truth about the stock market. There are always major risks that'll have investors reluctant to put money in the market. And there are often unexpected shocks that'll come with big scary sell-offs. But even when things are still bad, stocks rally as investors look past the challenges and bet that consumers and businesses will figure out a way to make things better.

In other words, it's never a given that stocks will fall.

By Sam Ro, managing editor. Follow him at @SamRo

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