By STAN CHOE, AP Business Writer
NEW YORK (AP) – The job of the Federal Reserve, said its longest-serving chairman, is to “pull the bowl of punch when the party starts”, and that is exactly the message Wall Street has taken from the comments from current president Jerome Powell. this week.
Stock prices fell after Powell said the Fed could end its overwhelming support for financial markets sooner than expected on Wall Street. History suggests, however, that stocks don’t always lose out when the Fed pulls out its aid.
Some economists and investors were already calling for such a move given the strong economic recovery after the brief recession last year and the stubborn persistence of high inflation sweeping the world.
But the S&P 500 fell 1.9% in a day after Powell said the Fed’s monthly bond purchases, which recently started to decline by $ 120 billion, could end months earlier than the June target it had been set for. Added to concerns about the novel coronavirus sweeping the world, this has caused Wall Street’s so-called “fear gauge” to rise sharply.
Wall Street has reason to be concerned. An early end to the Fed’s bond buying program, which has helped keep long-term interest rates low and thus bolster the economy, would allow the central bank to make the most important decision of start raising short-term interest rates.
These have been stuck at a record low near zero since the start of the pandemic, one of the main reasons the S&P 500 has roughly doubled since hitting a four-year low in March 2020 Low rates are also a main reason many investors have dismissed fears that stock prices have climbed too high, too fast.
An investor who buys a 10-year treasury bill, for example, envisions a return of just 1.44%, without even tracking current inflation levels.
âAs long as the 10-year remains below 1.50%, there is no alternativeâ to buying stocks, said Josh Wein, portfolio manager at Hennessy Funds.
To see how this increased Wall Street, consider what investors pay for every dollar in company profits. The price of the S&P 500 is trading at nearly 24 times the earnings per share its companies have made in the past 12 months, according to FactSet. That’s more expensive than its average price-earnings level over the past two decades of just under $ 18.
But stocks could continue to rise even after the Federal Reserve starts raising interest rates. Usually, such rate hike campaigns occur when the US economy has enough strength to stand up, without the help of the central bank. And that in itself can increase corporate profits, the lifeblood of the stock market.
Since 1983, the S&P 500 has performed positively in the 12 months following the start of a rate hike campaign in six of the seven occurrences, according to BofA Global Research. The average yield was 6.1%.
Widen the time horizon to two years after the first rate hike, and the S&P 500 has consistently had a positive return in all but one case.
Certainly, this exception has a similarity to the current market, according to Savita Subramanian, equity strategist at BofA Securities. The S&P 500 was much more expensive than normal in 1999, in the midst of the dot-com bubble, with S&P 500 prices trading at 30.5 times their earnings.
The all-time high for US stocks to perform when the Fed slows down its bond purchases is not so deep. Indeed, these bond buying programs have only become an integral part of the central bank’s toolkit since the 2008 financial crisis.
Stocks struggled a bit in the summer of 2013 when Fed Chairman Ben Bernanke suggested it could start slowing or cutting its bond purchases. This took investors by surprise, and the ensuing mini-market swoon became known as the âtaper tantrumâ.
But equities nonetheless quickly returned to the upside. The Fed did not finally raise short-term interest rates until the end of 2015, more than two years after the typed tantrum.
“While some fear that the end of the cut will accelerate the point at which interest rates rise, I don’t think that will happen, although this fear of higher rates adds to market nervousness in the short term,” said David Bahnsen, chief investment officer. Officer at The Bahnsen Group.
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