Fed Policy-Driven Super Rallies and Corrections in US Stocks | Sven Henrich

The US market is at a critical juncture with a contentious election, a Fed meeting, and numerous earnings reports on the horizon. A significant liquidity rally is underway, raising hopes for a year-end rally, yet concerns about a potential corrective move linger, especially after an 11-month rise. Despite strong bullish sentiment, skepticism remains due to insufficient changes in underlying conditions and earnings not meeting expectations. The S&P 500 is now at approximately 5,800, with some analysts projecting levels as high as 6,600, but these optimistic forecasts prompt concerns about sustainability.

Super rallies and corrections in the S&P, driven by interest rate cuts and hikes (2016–2024).

 

Liquidity-driven super rallies, influenced by Fed policy on interest rates, are characterized by prolonged market increases with minimal price discovery. The first major super rally in the above chart followed the earnings recession of 2015-2016, fueled by tax cuts and global quantitative easing. Subsequent rallies occurred despite rate hikes, indicating a strong influence from central banks and government policies. These rallies often persist until liquidity conditions shift, such as through rate increases or unexpected events. 

 

Currently, global central banks are signaling easing policies, contributing to the ongoing liquidity rally. Fiscal dominance, marked by significant deficits, plays a crucial role in this environment. The unprecedented $1.6 trillion deficit in 2023 raises questions about recession potential amid fiscal stimulus. Past experiences show that downside movements typically arise when liquidity changes. The current market situation highlights a disconnect between strong policy support and underlying economic conditions. Overall, these factors suggest that the rally extend through the end of the year or into 2025, but risks remain.

 

Reference:

Sven Henrich (October 27, 2024) - NorthCast Market Update: Markets at a Crossroad. (video)

Markets expect the Federal Open Market Committee to 

cut interest rates again by 0.25% on Thursday, November 7.

 

The median Nasdaq 100 (NDX) return from October 27th to December 31st is +11.74% since 1985.  
The median S&P 500 return from October 27th to December 31st in election years is +6.25% since 1928. 

— Goldman Sachs, October 27, 2024.

 

See also:
Sven Henrich (January 14, 2024) - The Cynic’s Guide to Markets.

The FOMC-Cycle Pattern of Stock Market Returns

Source: R-bloggers 

Since 1994 the equity premium in the US and in the rest of the world is earned entirely in weeks 0, 2, 4 and 6 in FOMC cycle time, i.e. in time since the last Federal Open Market Committee meeting. This likely reflects a risk premium for news (about monetary policy or the macro economy) coming from the Federal Reserve: 

(1) The FOMC calendar is quite irregular and changes across sub-periods over which our finding is robust. 
(2) Even weeks in FOMC cycle time do not line up with important macro releases. 
(3) Volatility in the federal funds market peaks during even weeks in FOMC cycle time. 
(4) Information processing/decision making within the Fed tends to happen bi-weekly in FOMC cycle time: The bi-weekly cycle is driven mainly by even week observations that follow board meetings of the Board of Governors. 

Furthermore, before 1994, intermeeting target changes were common and disproportionately took place during even weeks in FOMC cycle time. High return weeks do not line up with public information releases from the Federal Reserve or with the frequency of speeches by Fed officials. Systematic informal communication of Federal Reserve officials with the media and the financial sector is a more plausible information transmission mechanism. We discuss the social costs and benefits of this method of communication.  

Source: Anna Cieslak, Adair Morse, Annette Vissing-Jorgensen (June 12, 2016) - Stock Returns Over the FOMC Cycle. Duke University; 63 p. (HERE + HERE)

The Economist (Sep 3, 2016) - Meetings of the Federal Open Market Committee (FOMC), in which Fed governors and regional Fed presidents set interest-rate policy, can trigger rises and falls in the stockmarket [...] Usually every fortnight between FOMC meetings, fresh information is discussed in a gathering of Fed governors [...] gains in the stockmarket have occurred, on average, in the weeks of the FOMC meetings and the ones that involve the governors alone. A dollar invested only during those weeks would have grown more than 12-fold over the period. A dollar invested during other weeks would have lost half its value.