Year to date, the S&P 500 (SNPINDEX: ^GSPC) has added 13%, and the Nasdaq Composite (NASDAQINDEX: ^IXIC) has added 14%. Strong corporate financial results and economic resilience, fueled by large investments in artificial intelligence, have been the driving forces behind those double-digit returns.
However, investors just got bad news from the Federal Reserve. Three officials voted to increase interest rates when the Federal Open Market Committee (FOMC) met in July, and history suggests a new hiking cycle could sink the stock market.
Missed Nvidia in 2009? This Rare Signal Is Flashing Again. In 2009, a “Double Down” signal flashed for a little-known chipmaker called Nvidia. For the first time in years, that same “Total Conviction” signal is flashing for a company 1/100th the size of Nvidia. Continue »
Here are the important details.
Inflation has now exceeded the Federal Reserve’s 2% target for five years
The Federal Reserve operates under a dual mandate whereby its monetary policy decisions are supposed to promote price stability and maximum employment. Price stability does not mean no inflation, but rather 2% inflation, as measured by the PCE (Personal Consumption Expenditures) price index.
PCE inflation accelerated to 4.1% in May as the Iran conflict disrupted oil supplies moving through the Strait of Hormuz, a critical chokepoint in the Persian Gulf. That was the highest reading in three years. PCE inflation cooled slightly to 3.7% in June as geopolitical tensions eased, but projections point to similar readings for July and August, meaning inflation is sticky.
So what? PCE inflation has exceeded the Federal Reserve’s 2% target in every month since February 2021, meaning the FOMC has failed to achieve price stability for over five years. To that end, three FOMC officials (out of 12 voting members) wanted to raise interest rates in July. For context, zero FOMC officials wanted to raise rates in June.
Higher interest rates are typically a headwind for the stock market. Not only do higher rates make bonds more attractive, which can pull money away from equities, but they also slow corporate earnings growth by raising borrowing costs. The mechanism is simple: High rates directly raise interest expense and indirectly suppress spending.
If the Fed raises interest rates, history says a stock market correction will follow
The Federal Reserve has initiated five tightening (rate-hiking) cycles during the last three decades. After the first hike in each cycle, the S&P 500 and Nasdaq Composite fell by an average of 10% and 12%, respectively, at some point during the next three months. The chart below contains specific details.
