Why rejuvenation is good for the stock market, according to history

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The Fed is tapering off, and unlike the central bank’s 2013 reduction in monthly purchases of government bonds and mortgage-backed securities, the stock market took it calmly. Or did it? When then Fed chairman Ben Bernanke surprised the market in 2013 by suggesting that the Fed would stop buying bonds, stocks fell about as much as the retreat that began earlier this fall in a seemingly unstoppable market that was already on the Fed -Cone. And with all the memories of the “taper tantrum,” the market returned in 2013-2014 just as the market is now, making up for the October retreat loss and breaking new records for the Dow Jones Industrial Average this month. S&P 500 and Nasdaq Composite.

What’s next for stocks? If the tale of rejuvenation and the much longer story of market sentiment of 60 years is the judge, more gains are to come, potentially across all sectors, styles, and sizes of stocks in the S&P 500 and S&P Composite 1500 Indexes, according to CFRA Research data.

According to Bernanke’s taper comments in May 2013, stocks were down 5.8% for the next month – which is the smaller side of sales in the technical definition of a market pullback – between 5% and 10% – and for the remainder of the year the market rose by 17.5%.

“Stocks rose after a very small pullback known as the ‘Taper Tantrum’,” said Sam Stovall, CFRA Research’s chief investment strategist. “Above-average market returns in all styles, sectors and up to 80% of all sub-sectors.”

This applies not only to the market rally after the “tantrum,” but also to the 10 month period that included the actual Fed tapering activity.

In the 10-month tapering period from mid-December 2013 to the end of October 2014, the S&P 500 rose 11.5%, according to CFRA Research. The likely rationale, Stovall said, is that if the economy was strong enough to withstand the removal of supportive bond-buying activity, investors concluded that it was healthy enough to continue expanding on its own.

Federal Reserve Chairman Jerome Powell leaves a meeting in the office of Senator Chris Van Hollen, D-Md., In the Hart Building on Wednesday, October 6, 2021.

Tom Williams | CQ Roll Call, Inc. | Getty Images

“Don’t get other people’s word. There was a tantrum, the S&P 500 fell less than 6% in that month, but people are pretending there is a bear market close by,” said Stovall. “In the end it was hardly a pullback.”

And this taper ticker tape is part of what leads Stovall to conclude that the 5.2% retreat this September will end like so many market sell-offs in the past – it quickly broke even, ” and then the story begins, ”he said.

In 60 cases since World War II, when stocks fell, the market continued to rise for the next calendar month, an average of 3.3% – and up 92% of the time. In this case it would be November (October was the “back to break-even” month). The hot start to this month should not come as a surprise, given that the average return in the calendar months that follow a pullback-to-break-even cycle is 3.3% according to history.

Pullbacks are normal in stocks and common in longer bull markets. In fact, CFRA data shows that over the next 100 calendar days after these recovery months, the market rose an average of 8.4%. This time it would mean a rally until the end of January. But history says investors should be prepared for another bout of volatility afterward. Stocks have tended to slide into a new drop of 5% or more, according to S&P 500 history, which in this cycle would bring the retreat to February, historically (and specifically) the second worst month of the year for stocks.

Beware of the market floods in February

And in February there is something else that could create some market volatility – then the appointment of Jerome Powell as Fed chairman will have to be renewed or a new Fed chairman elected. The Fed is not meant to be a political beast, but given the upcoming midterm elections and fears that a sudden change in interest rate policy could plunge stocks and even force a recession, it would be logical for President Biden to retain the presidency at the helm of the central bank, the has clearly shown its patience with the current inflation period.

While history shows that in the three months leading up to the interim and presidential elections, the Fed was ready to raise rates, “I think they’d rather wait,” said Stovall. “The Fed wants to take its time to raise interest rates so as not to have a political impact.”

The market is not yet convinced. CME Fed Watch’s forecast still sees the possibility of interest rate hikes starting as early as the third quarter of next year.

Inflation and the battle between the Fed and investors over the course of inflation are likely to remain the main determinant of market sentiment. Powell reiterated after the Fed’s FOMC meeting this week that he is in no hurry to hike rates and continues to view inflation as temporary and likely to ease once Covid-specific factors, including supply chain bottlenecks, resolve on their own although he said this could last “well into next year”.

Many investors, from the billionaire class to the wealthy do-it-yourself investors, disagree.

CFRA expects the first quarter-point rate hike to occur in the fourth quarter of 2022 and proceed at a measured pace through 2023, but inflation will continue to rise until then. Headline CPI is expected to rise from 1.2% year-over-year in the fourth quarter of 2020 to 6% in the fourth quarter of 2021, and that it will start hitting short-term rates once the bond purchases are completed.

“In other words, the Fed has started to take its foot off the gas but is not ready to hit the brakes,” said Stovall.

Inflation could change that attitude. The current CPI forecast for the fourth quarter of 6% is said to be the peak of inflation. But what if not?

If the Fed continues to insist on holding off rate hikes, it could move faster on the taper. “I think if we end up with higher and longer inflation then the Fed may have to speed up the schedule of when and by how much to properly taper,” said Stovall.

A “simple straight line” is currently planned, he said – $ 10 billion a month in treasuries and $ 5 billion in mortgage-backed securities, which will be closed by the end of May.

However, if inflation data continues to come in hotter than expected next year, “there is concern that the Fed will have to increase the pace of the cut itself, and that increases the likelihood that the Fed will hike rates and do so sooner.” than expected, “said Stovall.

So while historical market data on the rejuvenation and six decades of market history instill some technical confidence, “interest rates and inflation remain the biggest potential pullback catalyst,” Stovall said.

CFRA predicts inflation will fall below 3% and to 2.5% around this time next year, after peaking at 5.9% in the headline this quarter. That’s the “passing” argument Fed Chairman Powell is sticking to, and Stovall said the economists CFRA relies on believe he’s right, but for stocks, “it just depends on the length of the transition “.

“If we see inflation stubbornly high, or even higher in Q1, it will scare the market,” he said.

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