Jim Cramer recently stated it will be time to buy stocks when the Fed pivots.
Of course, such sentiment is not surprising given that over the last decade, investors have repeatedly been beaten into submission to buy stocks when the Federal Reserve is easing monetary policy. Such was a point we discussed in
Ringing The Bell
Pavlov’s experiment is an excellent example of “classical conditioning” concerning investing.
In 2010, then Fed Chairman Ben Bernanke introduced the to the financial markets by adding a to the Fed’s responsibilities – the creation of the
Importantly, for conditioning to work, the when introduced, must be followed by the for the to be completed. For investors, each round of introduced the the stock market rose, the
Fed Balance Sheet vs S&P 500
Given the weight of the evidence from the past decade of market performance, it makes sense that stocks should perform better if the Fed from monetary tightening.
Here is the problem with Jim Cramer’s statement. It is incorrect.
Fed Pivots & Recessions
Since 2009, the market and economy have responded negatively whenever the Fed moves away from monetary easing. Such is not just a domestic issue, as the ECB, PBOC, and the BOJ have engaged in similar monetary accommodation programs. The last time the Fed began hiking rates and reducing its balance sheet was in 2018. The Fed reversed course just a couple of months later and 20% lower in the financial markets. Then, in 2020, the Fed massively infused markets with liquidity as the economic shutdown rocked the financial markets.
Fed Balance Sheet vs S&P 500
It would seem Jim Cramer is correct that when the Fed pivots, such is the time to buy stocks. Unfortunately, it isn’t as evident as it seems when looking back through time.
As shown below, since the 1960s, the Fed has repeatedly hiked interest rates to combat inflation. Notably, the stock market continues to perform when the Fed is lifting interest rates. Each time, that increase in the stock market, as the Fed was hiking rates, led investors to believe that this time was different. However, the Fed paused or pivoted from monetary accommodation as an economic recession or crisis was realized.
Fed Funds Pivot Periods
Such is the case because the Federal Reserve is operating on lagging data such as inflation and employment to dictate monetary policy changes. Since it takes 6-9 months for changes to interest rates to work their way through the system, it is too late when the data reflects a policy error.
The following chart of the unemployment rate, recessions, and the Fed funds effective rate shows the problem. Currently, the Fed is hiking rates as unemployment remains very low. However, the unemployment rate historically sharply reverses upon the realization of an economic recession as the Fed slashes rates.
Fed Rate Hikes, Unemployment, and Recessions
While it may seem logical to when the Fed makes its initial pivot, history suggests such a call is often an early event. Given the Fed changes direction once it realizes it has made a policy error, the market is generally in the midst of a bear market.
There is another problem with Cramer’s “buy the pivot” call. Given inflation presents a new dynamic not witnessed in 40 years, such suggests the Fed likely won’t pivot anytime soon.
The Fed Likely Won’t Pivot Any Time Soon.
The Federal Reserve’s sole focus is to bring inflation down to its 2% target rate. Given that inflation is currently running near 9%, the Fed has a lot of work to do. As St. Louis Fed President James Bullard stated this week:
There is a lot in that statement. As noted above, as the Fed further tightens monetary policy, such will slow economic and earnings growth. Such will make valuations harder to justify at current levels.
Secondly, the market and credit spreads give the Federal Reserve plenty of room to operate. As we noted previously, when it comes to the financial markets, the Fed’s primary focus is “financial stability.”
Currently, there are NO signs of financial stress, much less instability. From the Federal Reserve’s perspective, despite the decline in asset markets in 2022, investors are still 23% higher than at the market’s peak in 2022. Absent a disorderly meltdown; the Fed will remain focused on stocks being still above their pre-crisis peak. As BofA notes:
How The Fed Sees Finanical Conditions
Secondly, while credit spreads have risen, they are still well controlled, suggesting that financial stress in the credit markets remains low.
While Jim Cramer, and most investors, are salivating at the idea of a Fed pivot, with little stress in the credit market, the Fed can remain focused on combating inflation.
However, make no mistake, as the Fed continues to hike rates, there is an increasing risk that markets rapidly become .
Will the Fed their rate hikes?
That answer is
The only questions are and
What is clear is that the time to buy stocks is not when the Fed pauses but when the Fed funds rate returns to the zero bound.