Investors have 'Sweaty Palms' Waiting for the Fed
by Wade Slome, CFA, CFP, Sidoxia Capital Management
My palms are clammy, heart-rate is elevated, and sweat has begun to
drip down my brow. There I sit with my hands clenched in the doctor’s
office waiting room. I’m trying to mentally prepare for the inevitable
poking, prodding, and personal invasion, which will likely involve
numerous compromising cavity searches from head to toe. The fun usually
doesn’t end until a finale of needle piercing vaccinations and blood
tests are completed.
Every year I go through the same mental fatigue war, battling every
fear, uncertainty, and doubt. Will the doctor find a new ailment? How
many shots will I have to get? Am I going to die?! Ultimately it never
turns out as badly as I expect and I come out each and every doctor’s
appointment saying, “Well, that wasn’t as bad as I thought it was going
to be.”
Investors have been nervously sitting in the waiting room of the
Federal Reserve for the last nine years (2006), which marks the last
time the Fed increased the interest rate target for the Federal Funds
rate. In arguably the slowest economic recovery since World War II,
pundits, commentators, bloggers, strategists, and economists have been
speculating about the timing of the Fed’s first rate hike of this
economic cycle. Like anxious patients, investors have fretted about the
reversal of our country’s unprecedented zero interest rate monetary
policy (ZIRP).
Despite dealing with the most communicative Federal Reserve in a few
generations signaling its every thought and concern, uncertainty somehow
continues to creep into investors’ psyches and reign supreme. We
witnessed this same volatility occur between 2012-2014 when Ben Bernanke
and the Fed decided to phase out the $4.5 trillion quantitative easing
(QE) bond buying program. At the time, many people felt the financial
markets were being artificially propped up by the money printing feds,
and once QE ended, expectations were for exploding interest rates and
the stock market/economy to fall like a house of cards. As we all know,
that prediction turned out to be the furthest from the truth. In fact,
quite the opposite occurred. Investors took their medicine (halting of
QE) and the market proceeded to move upwards by about +40% from the
initial “taper tantrum” (talks of QE ending in spring of 2012) until the
actual QE completion in October 2014.
The thought of rate hike cycles are never fun, but after swallowing
the initial rate hike pill, investors will feel just fine after coming
to terms with the gentle trajectory of future interest rate increases.
The behavioral model of 1) investor fear, then 2) subsequent relief has
been a recurring process throughout economic history. As you can see
below, the bark of Federal Reserve interest rate target hikes has been
much worse than the bite. Initially there is a modest negative reaction
(approximately -7% decline in stock prices) and then a significant
positive reaction (about +21%).
With an ultra-dove Fed Chief in charge, this rate hike cycle should
look much different than prior periods. Chairwoman Yellen has clearly
stated, “Even after the initial increase in the target funds rate, our
policy is likely to remain highly accommodative.” Her colleague, New
York Fed Chair William Dudley, has supported this idea by noting the
path of rate hikes will be “shallow.”
Even if you are convinced rate hikes will cause an immediate
recession, history is not on your side as shown in the study below. On
average, since 1955, the time to a next recession after a Fed Rate hike
takes an average of 41 months (ranging from 11 months to as long as 86
months).
As a middle aged man, one would think I would get used to my annual
doctor’s check-up, but somehow fear manages to find a way of asserting
itself. Investors’ have been experiencing the same anxiety as
anticipation builds before the first interest rate hike announcement –
likely this week. Markets may continue their jitteriness in front of the
Fed’s announcement, but based on history, a ¼ point hike is more likely
to be a prescription of economic confidence than economic doom.
Everyone should feel much better leaving the waiting room after Janet
Yellen finally begins normalizing an unsustainably loose monetary
policy.
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