In an effort to further refine our 2022 Outlook, we have taken a look at the market’s historical response to changes in the Fed Funds Rate. Using Federal Funds Effective Rate data, available at
St. Louis Fed’s FRED database, since July 1954, we have compiled the following charts. The first two charts of the S&P 500 and NASDAQ offer of quick comparison of a few basic scenarios. Based upon the annual change in Fed Funds Effective Rate, data was grouped into three categories: Higher, Lower, and No Change (NC). For NC, a range of plus/minus 0.2% was used. The All line represents all years in the data set.
On average, it would appear as though changes in Fed Funds Rate generally did not have a significant effect on the S&P 500 or NASDAQ. Years where Fed Funds Rate did not change or changed less than +/- 0.2%, historically performed the best. On average S&P 500 averaged just under 12% for the full year while NASDAQ averaged over 25%. The most recent year to fall into this category was 2021.
Higher Years and Lower Years failed to show any substantial deviation versus All Years. This was a somewhat surprising result considering the biggest increase in one-year rates was 7.23% (from 14.77% at the end of 1979 to 22.00% at the end of 1980). In 1980 the S&P 500 gained 25.8% and NASDAQ rose 33.9%. The largest one-year decrease in rates was 8.87% (from 22.00% at the end of 1980 to 13.13% at the end of 1981). In 1981, S&P 500 declined 9.7% and NASDAQ fell 3.2%.
In these next two charts we expanded the number of categories that a given year could fall into based upon the magnitude and direction of the change of Fed Funds Rate. No Change is the same range used previously, from -0.2% to +0.2%. 1% includes any year where the rate increased more than 0.2% but not more than 1%. The 2% group covers 1% to 2% while any increase exceeding 2% went into the >2% group.
With this approach one group easily stands out while the rest still exhibited relatively subtle changes. Years in which Fed Funds Rate was cut by 2% or more, were a disaster on average. Which is consistent with current Fed practice of rapidly lowering Fed Funds Rate in response to adverse economic conditions. These years were 1974, 1981, 1987, 1990, 2001, 2007 and 2008. Prior to the Covid-19 Pandemic, Fed Funds had declined in 2019 and was only cut 1.46% in 2020 (1.55% at yearend 2019 to 0.09% at yearend 2020).
NASDAQ appears to perform best when rates are unchanged or modestly lower (no more than a 2% drop in a year). S&P 500 also appears to favor unchanged to modestly lower rates but appears to be more resilient when annual increases were less than 2%. Interest rates do play a role in the markets overall performance, but it is not the only factor. Employment, overall economic growth, inflation, and taxes all impact corporate earnings. Sentiment and momentum can also drive prices to levels (up and down) that may appear to have little to no connection to reality. The market has entered the Weak Spot of the 4-Year Cycle, inflation is still at multi-decade highs, the Fed is tightening, sentiment is bearish and support levels are not holding. Continue to be patient as the Weak Spot will eventually give way to the Sweet Spot of the 4-Year Cycle sometime later in Q3 or early Q4.
Stock Portfolio Updates
Over the last four weeks since last update through yesterday’s close, S&P 500 declined 11.5% while Russell 2000 dropped 15.2%. Over the same time period the entire stock portfolio slipped 2.8% lower, excluding dividends and any fees. The overall portfolios sizable cash balance is what held declines at bay. Cash is now 74.7% of the total portfolio. This is not a target; it is the result of heeding stop losses and closing out Free Lunch positions along with the seasonal overlay applied to the portfolio.
When cash is excluded and stock-only holdings are reviewed, Large caps held up best, off 6.7%. Small-cap holdings slide 9.1% and Mid-caps fell by 13.0%. In total five positions were stopped out over the last four weeks. Housing market related North American Construction (NOA) and Sterling Construction (STRL) were stopped out of the Small-cap portfolio this month. Material costs and briskly rising mortgage rates are likely the main reasons.
Pacira BioSciences (PCRX) was stopped out on May 9. PCRX had been bucking the broad market trend this year with solid gains, but earnings apparently were a bit of a disappointment for already “on edge” investors. Sizable increases in expenses and R&D spending were not received well either.
Abbott Labs (ABT) was also stopped out earlier this month. Shares had been struggling for most of the year in a slow downward trend. ABT’s involvement in the mounting baby formula crisis has likely also spoiled some investor’s moods. Lastly, Infosys (INFY) was stopped out one day after last months update.
All other positions are on Hold. Please see the table below for updated stop losses and current advice for positions not covered above.