Broker Check
Research Highlights - 12/06/2023

Research Highlights - 12/06/2023

December 06, 2023

If market participants seem to be overly obsessed with the direction of the Federal Funds Rate (FFR), then we should dedicate a research highlight to its level over the past two decades. Additionally, we should include the 10 Year US Treasury rate alongside it. And for good measure, we should take note on the S&P 500 Index return during specified periods of observation. Are there relationships between these variables that we could rationally deduce? If so, what may this indicate for the US stock market returns from 12/31/2023 to 12/31/2029?

First Period of Observation: 12/31/1999 to 12/31/2009 - "The Lost Decade"
During this period, the total return for the S&P 500 Index was an annualized loss of -0.95% per year. The cumulative loss during this period, which was plagued by two US recessions, totaled -9.10%. (Figure 1) For this exact same period, the 10 Year US Treasury rate declined steadily from over 6.25% to 3.85%, while the FFR oscillated from over 6% to 1% to 5% to 0.05%. (Figure 2) Since the FFR is a primary monetary policy tool of the Federal Reserve, it's no surprise that the FFR level was actively managed upwards and downwards and upwards again prior to, between, and during economic recessions. Setting aside our judgment as to whether such monetary tool utilization was effective or not, the plain observation is that dramatic movements of the FFR did not highly correlate to dramatic movements in the long-term risk-free rate (aka, 10 Year US Treasury). This could indicate that future FFR decreases will not impact market rates. Furthermore, given the Fed balance sheet asset runoff (currently about $90B per month), the primary buyer in the Treasury market is dormant. This could further support market rates, as bond prices and yields are inversely correlated.

Second Period of Observation: 12/31/2009 to 12/31/2019 - "The Raging Bull"
This decade demonstrated a pronounced upward trajectory for the S&P 500. Over the decade, a 256.7% total return was achieved with a few brief corrections and absent of any US recession (Figure 3). The 10 Year US Treasury Rate continued its decline from the prior decade, as an aggressive ultra-accommodative monetary policy was pursued post Great Financial Crisis. The FFR hovered near 0% for the majority of this decade (Figure 4). Capital markets experienced an extraordinary imbalance, as debt markets and access to capital were made easy and low-risk with significantly lower-than-inflation-rate cost of capital. As such, market participants consistently looked to stocks as their source of cash flow (through stock dividends) and growth (through capital appreciation of shares). The markets were void of "normal" income investment opportunities that had been present in every other decade throughout US economic history.

Third Period of Observation: 12/31/2019 to 11/30/2023 - "The Post Pandemic Era"
The start of this decade took a page from the prior decade's playbook. Early on, the FFR was taken quickly to 0% in the aftermath of the perceived pandemic related economic challenges, while the 10 Year Treasury wallowed below 1.50% until early 2022 (when the Federal Reserve began implementing their restrictive monetary policy) (Figure 5). With the FFR hitting 5.33%, for the first time in many years, the 10 Year Treasury Rate falls below by nearly 100 basis points at 4.37%. Since early 2022, when the Fed's FFR hiking cycle began, the S&P 500 has been trading within a narrow range, relative to its 12/31/2019 level (Figure 6). This is an important observation, since the interest rate environment has dramatically shifted to levels last seen prior to the Dotcom Bubble Burst (2001 Recession).

As market participants come to understand that a paradigm shift in our capital markets has occurred, resulting in a return to economically healthy cost of capital through its debt functions, stock market prices are expected to remain vulnerable. Companies whose shares have experienced a disproportionate demand (e.g., "The Magnificent Seven") could be even more prone to downside pricing risk.

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