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Federal Reserve pauses have surprisingly little significance for U.S. stock market investors. I’m referring to the Fed’s recent decision not to raise rates, after having increased them in each of its 10 previous meetings. It is being referred to as a “pause” because of the widespread expectation that the Fed will resume raising rates at subsequent meetings, most likely at its next one in July.
Though many claim that this one-meeting hiatus has great significance for the equity market, my analysis of past Fed pauses does not support these claims.
My conclusions are necessarily tentative, since there’s no one definition of a pause. For the purposes of this column, I focused on all rate-hike cycles since 1990 during which the Fed changed course from raising rates at every meeting to waiting two meetings to do so. This definition yielded six past pauses.
Notice that there would have been no way to identify those six pauses in real time. When the Fed decides not to raise rates, after having done so for several previous meetings in a row, investors can’t know whether the rate-hike cycle has come to an end, or has merely been paused. Only when the Fed decides to resume raising rates at its subsequent meeting can we know for sure that there was a pause.
In any case, I found no consistent pattern to how the stock market performed in the wake of these six pauses. Sometimes the market rose over the subsequent month, quarter, six months, or year, and sometimes not. The stock market’s average return over these periods was not statistically different than it was the rest of the time.
Good luck extrapolating this history into a profitable forecast. Maybe this is why the U.S. stock market, after rallying strongly in the immediate wake of the Fed’s meeting, has since declined to more or less where it stood before.
Impact on corporate earnings
You might argue that, based on a discounted cash flow model, the stock market should be higher today because of the Fed pause than it would have been otherwise. After all, if you use the Fed funds rate to discount future earnings and dividends, stocks are worth more today — with the Fed funds rate at 5.25% — than if the Fed had instead raised rates a quarter point at its June meeting to 5.50%.
But this increase is not enough to make any real difference, according to John Graham, a professor at Duke University’s Fuqua School of Business. In an interview, Graham said that a month’s delay in raising interest rates in and of itself makes not even a miniscule difference to the discounted value of a company’s future earnings and dividends. The present value of, say, 20 years of earnings and dividends discounted at 5.5% is virtually indistinguishable from what it would be when discounted for one month at 5.25% and 19 years and 11 months at 5.5%.
Might it be that a one-month delay in hiking the Fed funds rate to 5.5% causes a corporation to make different capital allocation decisions than it would have otherwise? That is extremely unlikely, Graham added, based on responses to the Duke/CFO Global Business Survey, of which he is the director.
The bottom line? The Fed’s pause in and of itself carries little significance. The financial media’s obsession with it is little more than a lot of sound and fury signifying nothing.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
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