Central banks. Big rally jitters. Elections. Markets may have seen this movie before.
Forgive us for feeling like we are in our own version of Groundhog Day.
Last week, investors overinterpreted the tea leaves that Jay Powell and the Federal Reserve left after their meeting, a shocking U.S. regional bank earnings report revived worries over the sector, red-hot jobs data on Friday showed just how robust the U.S. economy is, and the 49ers and the Chiefs won the right to face each other in the Super Bowl. We haven’t even mentioned tech’s continued rise, or the likely election showdown between former President Donald Trump and current President Joe Biden.
But instead of wallowing in the same debates, we wanted to embrace the feeling of déjà vu to see if we could learn anything from the past. Here is what we found.
1. Strong starts tend to signal more strength ahead
When all was said and done, January ended with a nearly 2% return for U.S. stocks. While one month will never define a year, history suggests that starting strong is much better than not. Going back to 1950, years with a positive January usually see rallies of almost 17% and end with a gain nearly 90% of the time. When January is negative, the results are much worse. In that scenario, the S&P 500 has seen an average full-year decline of about 2% and has been positive only 50% of the time.
This bar chart shows the January and full year S&P 500 average return since 1950 in percent.
When January return is positive the average January return is 4.3%, and the full year average return is 16.8%.
When January return is negative the average January return is -3.7%, and the full year average return is -1.7%.
Of course, January continued strong momentum for markets in November and December. In fact, the S&P 500 gained over 15% in those three months. Also since 1950, the average return 12 months after a rally like that is also 17%, much higher than the average 12-month return of 9% for all other periods. No analog is perfect, and markets aren’t dictated by averages, but these observations suggest that investors haven’t missed the rally.
Tying this to our view on markets this year, we expect more gains ahead. Disinflation has more room to run. Earnings growth is just getting going, from big tech and other sectors alike (last week was case in point). And soft landings tend to be a pretty good time to invest.
2. When the Fed cuts, assets tend to outperform cash
Indeed, the key reason for our optimism this year is not counting stats like the ones above. It is our understanding of what is likely to happen as central banks lower interest rates amid a resilient economic backdrop. After the Federal Reserve’s meeting last week, Chair Powell acknowledged that it is very likely policymakers will cut rates this year, potentially as soon as May. The direction of travel is largely consistent across regions too, with the Bank of England and European Central Bank removing their tightening bias amid the progress we have seen on inflation.
To get a sense of what we should expect during a rate-cutting cycle, we looked at every one from the Fed since the 1970s. The first pattern that became clear was that core fixed income outperformed cash in almost every instance. This makes sense because core bonds offer investors the opportunity to lock in yields instead of being at the mercy of cash yields as the Fed lowers rates. For stocks, you need to go one level deeper. If the Fed is cutting rates to support the economy, stocks are probably not doing very well. But if the Fed is cutting rates outside of recession, stock returns have been exceptional: just over 30% on average across the instances we identified.
This table shows the market moves from the Federal reserves final hike to its last cut since 1970.
The first cycle with the last hike in August 1971, and last cut in December 1971, was a Soft landing, the change in policy rate was -225bps, the change in the 10-year yield was -71bps, the S&P 500 return was 6%, the U.S. core bonds return was 7%, and the U.S. cash return was 2%.
The second cycle with the last hike in May 1974, and last cut in April 1975, was a Recession, the change in policy rate was -775bps, the change in the 10-year yield was 65bps, the S&P 500 return was -3%, the U.S. core bonds return was 7%, and the U.S. cash return was 8%.
The third cycle with the last hike in March 1980, and last cut in June 1980, was a Recession, the change in policy rate was -1050bps, the change in the 10-year yield was -270bps, the S&P 500 return was -1%, the U.S. core bonds return was 17%, and the U.S. cash return was 4%.
The forth cycle with the last hike in May 1981, and last cut in December 1982, was a Recession, the change in policy rate was -1150bps, the change in the 10-year yield was -383bps, the S&P 500 return was 3%, the U.S. core bonds return was 44%, and the U.S. cash return was 25%.
The fifth cycle with the last hike in August 1984, and last cut in August 1986, was a Soft landing, the change in policy rate was -587bps, the change in the 10-year yield was -569bps, the S&P 500 return was 49%, the U.S. core bonds return was 52%, and the U.S. cash return was 19%.
The sixth cycle with the last hike in February 1989, and last cut in September 1992, was a Recession, the change in policy rate was -675bps, the change in the 10-year yield was -293bps, the S&P 500 return was 43%, the U.S. core bonds return was 52%, and the U.S. cash return was 28%.
The seventh cycle with the last hike in February 1995, and last cut in January 1996, was a Soft landing, the change in policy rate was -75bps, the change in the 10-year yield was -200bps, the S&P 500 return was 35%, the U.S. core bonds return was 18%, and the U.S. cash return was 6%.
The eighth cycle with the last hike in March 1997, and last cut in November 1998, was a Soft landing, the change in policy rate was -75bps, the change in the 10-year yield was -183bps, the S&P 500 return was 44%, the U.S. core bonds return was 18%, and the U.S. cash return was 9%.
The ninth cycle with the last hike in May 2000, and last cut in June 2003, was a Recession, the change in policy rate was -550bps, the change in the 10-year yield was -304bps, the S&P 500 return was -33%, the U.S. core bonds return was 42%, and the U.S. cash return was 11%.
The tenth cycle with the last hike in June 2006, and last cut in December 2008, was a Recession, the change in policy rate was -500bps, the change in the 10-year yield was -299bps, the S&P 500 return was -27%, the U.S. core bonds return was 15%, and the U.S. cash return was 10%.
The eleventh cycle with the last hike in December 2018, and last cut in October 2019, was a Soft landing, the change in policy rate was -75bps, the change in the 10-year yield was -105bps, the S&P 500 return was 20%, the U.S. core bonds return was 10%, and the U.S. cash return was 2%.
The twelfth cycle with the last hike in October 2019, and last cut in March 2020, was a Recession, the change in policy rate was -150bps, the change in the 10-year yield was -112bps, the S&P 500 return was -21%, the U.S. core bonds return was 3%, and the U.S. cash return was 1%.
3. Regional bank stress is a risk, but probably not for the broader economy
The flies in the ointment last week were the regional banks. The lender that purchased Signature Bank during last spring’s turmoil shocked investors by increasing their allowance for loan losses and slashing their dividend. This stoked a vicious ~9% sell-off in regional bank shares that were finally starting to feel more comfortable as the Fed started to ease up on interest rates.
As we noted last year small banks are also much more exposed to commercial real estate loans that were underwritten in a very different low interest rate environment. In our outlook, we wrote about how stress in regional banks and commercial real estate was likely to percolate throughout the year, despite the Fed’s pivot to easing. We believe such stress poses a risk to our outlook, but our experience from last year suggests this particular economic cycle is not very sensitive to regional bank lending, and the Fed has set the precedent that it would do what it takes to avoid worst-case outcomes.
For now, we think certain investors can earn a premium for providing capital in these areas where it is still scarce.
4. Markets tend to care more about fundamentals than elections
If we do end up with a Biden versus Trump election contest, it will be the first time since 1892 that both candidates of the two major parties have already served as President (back then, it was Cleveland versus Harrison). For markets, this means we already have an initial idea of potential policy proposals.
Taking cues from prior campaigns and time in office, former President Trump may look to extend his tax cuts due to expire next year, explore further de-regulation, push trading partners on their terms (whether that be China, Mexico, Canada, European allies or Iran), challenge some of the tenets in the Inflation Reduction Act (especially around green energy) and up spending on defense (but likely with less aid to Ukraine). Another term from President Biden may also seek to increase government spending (but more so around the energy transition) and stay tough on China. But he’s likely to be tougher on taxes, easier on immigration policy and more supportive to Ukraine aid.
That said, the race is still nine months out, with ample time to evolve, and getting policy proposals through also depends on what happens with Congress. For what it’s worth, stocks had strong, above-average runs in both the years that Biden and Trump were elected—a nod to our view that the economic backdrop tends to matter more.
This chart shows the S&P 500 performance around U.S. elections since 1980, Indexed to Election Day.
At 18 months prior to election day the price index in 1984 was 99, in 1992 was 91, in 1996 was 74, in 2004 was 82, in 2012 was 80 and the average of the price index across all elections since 1984 at 18 months prior was 97.
At 6 months prior to election day the price index in 1984 was 95, in 1992 was 99, in 1996 was 91, in 2004 was 98, in 2012 was 93 and the average of the price index across all elections since 1984 at 6 months prior was 100.
At 3 months prior to election day the price index in 1984 was 97, in 1992 was 101, in 1996 was 94,in was 2004 97, in 2012 was 95 and the average of the price index across all elections since 1984 at 3 months prior was 102.
At 6 months after election day the price index in 1984 was 108, in 1992 was 105, in 1996 was 116, in 2004 was 102, in 2012 was 104 and the average of the price index across all elections since 1984 at 6 months after was 106.
At 12 months after election day the price index in 1984 was 114, in 1992 was 112, in 1996 was 130, in 2004 was 106, in 2012 was 103 and the average of the price index across all elections since 1984 at 12 months prior was 113.
5. Stocks like both the 49ers and the Chiefs
Super Bowl LVIII is almost here, and it’s another rematch of the San Francisco 49ers and the Kansas City Chiefs. We won’t give our pick to win the title, but stocks at least seem to slightly favor the 49ers. Looking back at all 22 Super Bowl winners, the S&P 500 has rallied almost 20% on average in years that the 49ers have won (the third best, behind the Buccaneers and the Steelers). That said, markets seem to like the Chiefs too, with average gains of 13.5% in years they’ve won. Best of luck to both teams this coming weekend.
All market and economic data as of February 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.
Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.
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