The Fed That Didn’t Bark by Robert R. Johnson, PhD, CFA, CAIA, President and CEO, The American College of Financial Services
In Sir Arthur Conan Doyle’s short story Silver Blaze, Sherlock Holmes concludes that since a guard dog didn’t bark the dog was friendly with the intruder. Last week the Fed didn’t bark on raising interest rates because they’re friendly with the financial markets – perhaps too friendly.
After this inaction by the Fed, the equity markets seem to be very confused and appear to be trending downward. Many pundits were surprised that the stock market has not responded positively to the decision not to raise rates.
I believe that market participants are suffering from “Fed fatigue.” Interest rates are surely going to rise; it isn’t a matter of “if” but is merely a matter of “when.” I believe that last week the market would have welcomed a 25 basis point increase. It would have provided investors with more clarity – and we know that the market detests uncertainty. What happened is that the Fed simply kicked the can down the road a bit and we will go through this dance again in the coming months. As an aside, the Fed is reminding me of Congress kicking the can down the road a few years ago regarding the debt ceiling. Let’s hope the Fed doesn’t bring the markets to the precipice of disaster like our lawmakers did.
What does this “failure to bark” mean for the equity markets moving forward? I have spent a good deal of my career empirically investigating market performance with respect to Federal Reserve policy. My co-authors Gerald Jensen of Creighton University and Luis Garcia-Feijoo of Florida Atlantic University and I found in our recently published book Invest With the Fed that equity returns were significantly higher when the Fed was lowering rates than raising rates. From 1966 through 2013, the S&P 500 returned 15.2 percent in falling rate environments and only 5.9 percent in rising rate environments. And, there was a wider disparity in the returns to small stocks during rising and falling rate environments. The bottom line is that investors should lower their return expectations in the coming months and years when those inevitable rate hikes occur.
For the average investor with a long-term time horizon, the short-term actions of our beloved Federal Reserve should be of little concern. Hopefully, those investors are already largely concentrated in equities and simply understand that some market periods are characterized by higher returns than others and that “staying the course” gives them the best chance to build true long-term wealth.
While I would caution long-term investors to not significantly modify their asset allocations, my research does show that some equity sectors hold up very well in rising rate environments while others lag behind. For instance, energy, consumer goods, utilities and food stocks have proven to be solid investments when rates are trending upward. On the other hand, autos, durable goods, apparel and retail stocks have underperformed in rising interest rate environments. Some sector rotation may be warranted in advance of or in response to a Fed move.
For the typical retirement investor, the Fed non-move truly is a non-event. The best way for the average do-it-yourself investor to build wealth is to systematically invest in a low-cost equity index fund via dollar cost averaging. The old adage “Time in the market is more important than timing the market” should guide investors’ long-term strategy.
Robert R. Johnson, PhD, CFA, CAIA
President and CEO, The American College of Financial Services
Robert R. Johnson is President and CEO of The American College of Financial Services, a non-profit, accredited, degree-granting institution in Bryn Mawr, PA. He has extensively researched Federal Reserve monetary policy and capital market returns for the past 25 years.
Twitter is @BobAmericanColl
