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FIVE STEPS, WHERE’S THE STUMBLE?

The old Wall Street trader’s adage of “three steps and a stumble” refers to the stock market’s reaction to Fed rate hike cycles. At first, stock prices don’t react to the Fed raising rates, but eventually the market succumbs to the economic cooling effects of monetary policy, and a bear market usually begins after three rate hikes. Hence, “three and a stumble”. The chart below from Ned Davis Research shows the effects of this rule on the Dow. Historically, the DJIA has declined a median of -17.9% from sell signals to NDR market bottoms.

Historically, the sell signals have been fairly prescient, though sometime early. This expansion cycle has been unusual in that the Fed began raising rates two years ago. We have seen five consecutive quarter-point rate hikes, so where’s the stumble?

Our analysis shows that economic conditions represent a sweet spot for equity returns over the next 3–6 months. The odds of a U.S. recession is low, and the global economy is undergoing a synchronized cyclical upturn. Barring an incipient trade war between the U.S. and China, the S&P 500 has the potential to gain 7–11% in the next 6–9 months.