5 months ago • 2 mins
When the Federal Reserve (the Fed) puts the brakes on rate hikes, it often lets the market breathe and gives stocks a lift. That’s because rising interest rates give both financial assets and the economy a one-two punch, so when the onslaught stops, investors can stop bracing for the next hit. We’ve seen that relief play out this year, with stocks building positive momentum in anticipation of a brighter financial outlook. And as you can see in the chart, that’s normal: stocks tend to rise in anticipation before the last hike.
Thing is, historical averages and patterns can be misleading. Stocks don’t always behave in the same way after a final rate hike. Instead, their performance varies wildly depending on whether the economy's subsequently robust or weak. If the economy as a whole is shrinking, stocks tend to stay on the slide even after the last hike. That’s because economic slowdowns can sting corporate profits, which can easily overshadow any relief from cushier financial conditions.
The million-dollar question, then, is if the economy's headed for a recession or not. Wall Street's corridors may be filled with mutterings of soft landings, when the Fed eliminates inflation without bringing about a recession – but the truth is, recessions can suddenly spark when you least expect them. (A soft landing was also the main market narrative just before the 2008 financial crisis.) What’s more, the global pandemic and aggressive central bank policies have made it even more difficult to anticipate what’s going to happen next. Plus,it’s possible we haven’t yet felt the full aftershock from the Fed's aggressive hikes.
So in my opinion, you should prepare for the unexpected and ensure your portfolio is up for the challenge. If you’re cool with a tumultuous ride, you could hold steady. But for us mere mortals, a diversified portfolio, a cash cushion, and a solid game plan could completely change how your strategy plays out over the next decade.
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