Can we Unveil Past Market Wisdom for Today's Economic Environment?
As analysts at Dunham, we are always fascinated by the markets and constantly explore ways to gain an edge in our asset allocation strategies. One of our approaches involves looking at historical events that resemble the current market situation.
While we know that past performance does not guarantee future results and that every market is different, we believe that studying similar events in the past can provide valuable insights and help us make informed decisions.
We feel our curiosity and dedication to research drive us to uncover potential market strategies that may give us an advantage in navigating the ever-changing financial landscape.
This article will explore one of our latest curiosities.
Scope of the Research
We wanted to explore the relationship between the performance of the S&P 500 index and the Federal Funds Rate by examining historical data over the past 40 years.
Specifically, we investigated the average one-year return of the index following the Federal Funds Rate reaching its peak level and, separately, the average return starting three months before the Federal Funds Rate peak. The analysis reveals intriguing findings that shed light on the potential impact of monetary policy on stock market performance.
The industry widely uses the S&P 500 index as a benchmark for the U.S. stock market's performance, representing a diverse array of companies across various sectors. Understanding the factors that influence the movement of this index is of great importance to us as analysts. One such factor in today's financial market is the Federal Funds Rate, a key tool for the Federal Reserve to manage monetary policy.
Recent data suggests that inflation is gradually being brought under control, and the Federal Reserve has hinted at a potential slowdown in rate hikes. While there might be further adjustments in interest rates in the months ahead, indications suggest we may be approaching the end of this tightening cycle.
Against this backdrop, understanding the historical relationship between the performance of the S&P 500 index and the Federal Funds Rate, particularly in the period following the rate's peak level, becomes a pivotal data point for us as analysts.
To examine the relationship between the Federal Funds Rate and the performance of the S&P 500, we collected historical data for the past 40 years. We identified the dates when the Federal Funds Rate reached its peak level and recorded the corresponding one-year returns of the S&P 500 index.
We also calculated the average one-year return three months before the Federal Funds Rate peak. We used monthly returns for the analysis to capture the short-term fluctuations in the stock market.
The analysis of the historical data yielded intriguing findings. The average one-year return of the S&P 500 index following the Federal Funds Rate reaching its peak level over the past 40 years was 10.1%.
This average return might suggest that, on average, the stock market has demonstrated positive performance after the peak of the Federal Funds Rate. However, it is worth noting that individual performance varies significantly, as evidenced by the range of returns observed.
Moreover, the average one-year return starting three months before the Federal Funds Rate peak was notably higher, at 21.8%. This finding may suggest that there may be a lead time effect, where investors anticipate the Federal Funds Rate reaching its peak level and adjust their investment strategies accordingly.
Consider that this average also encompasses periods of negative returns, indicating that the stock market's reaction to the Federal Funds Rate can be complex and subject to various factors.
What Might This Mean?
The positive average one-year return following the Federal Funds Rate peak may suggest that the stock market has demonstrated resilience despite tightening monetary policy.
The historical data suggests that, on average, the S&P 500 index has shown positive performance following the peak of the Federal Funds Rate. The average one-year return after the Federal Funds Rate reached its peak level over the past 40 years stands at 10.1%.
Furthermore, the average one-year return starting three months before the Federal Funds Rate peak was higher, at 21.8%. These returns might suggest an anticipatory effect, where investors adjust their investment strategies ahead of the peak, potentially capitalizing on opportunities presented by changing monetary policy.
This finding could imply that as we reach what could be the end of rate hikes, investors should not be overly concerned about the immediate impact on the stock market, as it has historically demonstrated resilience and potential for growth in the following year.
However, it is crucial to note that the basis of these observations is historical data, and you should interpret these results cautiously. Past performance does not indicate future results; numerous other factors can influence the stock market. Economic conditions, geopolitical events, and global market trends, among others, can significantly impact investment outcomes.
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax, or investment advice or an investment recommendation, or as a substitute for legal counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy, or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
Past performance of an index is not an indication or guarantee of future results.
It is not possible to invest directly in an index.
Investments are subject to risks, including possible loss of principal. Investors should consider the investment objectives, risk factors, and expenses of any investment carefully before investing. Diversification does not guarantee profit or ensure against loss.
The S&P 500, or the Standard & Poor’s 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 Index components and their weightings are determined by S&P Dow Jones Indices. It differs from other U.S. stock market indices, such as the Dow Jones Industrial Average or the Nasdaq Composite index, because of its diverse constituency and weighting methodology. It is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy.
Sources of data are all public, from sources believed to be reliable and may include but are not limited to Reuters, Bloomberg, Standard and Poors, U.S. Bureau of Labor Statistics, Federal Open Market Committee, and Yahoo Finance.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA / SIPC. Advisory services and securities are offered through Dunham & Associates Investment Counsel, Inc.