How Equities Historically Have Performed After a Fed Pause

An Historical Analysis of 6 Previous Fed Pauses Over 4 Decades

The Federal Reserve’s decision to hit pause on a rate hike this month may change the complexion of the outlook for some investors. To better understand how a pause may affect equity performance, we examined U.S. returns around the last six times the Fed paused rate hikes from 1984 to 2018. On average, U.S. stocks performed well after a Fed pause while value outperformed growth.

Historical Market Performance Before the Fed Pauses

Stocks represented by the Russell 1000 Index exhibited positive performance on average during the months leading up to the Fed pauses we studied (see Exhibit 1). We don’t find that surprising. During the pre-pause periods, markets benefited from the perception of strong economic growth. After all, the Fed often was raising rates to try to rein in growth that it saw as too strong.

Patterns of returns varied somewhat over three-month versus six-month periods. Three-month market returns before a Fed pause averaged about 2.5%, and they were positive in four out of six periods. Six-month returns before a Fed pause averaged just under 4%, and they were positive in five out of six periods.

During these six periods, we also noticed something that might seem familiar to today’s investors. Near the end of the tightening cycle, investors have historically shifted toward defensive stocks as they started to see the impact of earlier hikes slowing economic growth and affecting corporate earnings.

EXHIBIT 1: A POSITIVE TREND IN POST-PAUSE EQUITY PERFORMANCE

In five of six Fed pauses, stocks performed positively six months after a Fed pause, for an average of nearly 13%

Exhibit 1

Source: Northern Trust Asset Management, Bloomberg. From February 28, 1984 to February 28, 1985, August 31, 1988 to August 31, 1989, August 31, 1994 to August 31, 1995, November 30, 1999 to November 30, 2000, December 30, 2005 to December 31, 2006, and June 29, 2018 to June 30, 2019. Past performance is no guarantee of future results. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Information is provided to illustrate typical sectors and securities that constitute the index. It should not be considered investment advice or a recommendation to buy or sell any security. There is no guarantee that securities remain in the index. It should not be assumed that any investments were profitable or will prove to be profitable.

Historical Market Performance After Fed Pauses

Similar to the pre-pause periods, markets generally delivered positive returns following Fed pauses. The scale of positive returns was even greater during the post-pause period. On average, during the three-month periods following a Fed pause, stocks rose 8% and were positive in five out of six periods. Averages increased by even more — just under 13% — during the six-month periods following a pause and were positive in five out of six periods.

The post-pause pattern of average sector returns over three- and six-month periods shows some interesting patterns with implications for investors. During the first three months following a Fed pause, information technology outperformed — thanks to euphoria about the pause — along with utilities.

The post-pause six-month average performance shows a dramatic reversal for information technology, with performance favoring defensive sectors led by consumer staples and followed by utilities and health care. We also found that six months out value outperformed growth, higher quality (high return on capital, strong cash flow) outperformed lower quality, and low volatility stocks outperformed high volatility stocks (see Exhibit 2).

EXHIBIT 2: SOME EQUITY FACTORS OUTPERFORMED AFTER FED PAUSES

Six months after Fed pauses on average, equity factors with the strongest value, quality and low volatility characteristics (quintile 1) outperformed those that scored lowest (quintile 5) on those characteristics. The multi-factor portfolio combines high quality, value, high momentum, small caps and low volatility.

Exhibit 2

Source: Northern Trust Asset Management, MSCI. The Fed pauses were on August 31, 1984; February 28, 1989; February 28, 1995; May 31, 2000; June 30, 2006; and December 31, 2018. Past performance is no guarantee of future results. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Information is provided to illustrate typical sectors and securities that constitute the index. Shows performance of Factor Mimicking Portfolios that are long-short. Value, volatility, and quality are MSCI Barra USE3 Factor definitions. Represents top minus bottom quintile by count. Multi-Factor portfolio represents equal weighted composite of high quality, value, high momentum, small caps and low volatility. It should not be considered investment advice or a recommendation to buy or sell any security. There is no guarantee that securities remain in the index. It should not be assumed that any investments were profitable or will prove to be profitable.

Practical Implications of Historical Patterns

Average patterns of market returns pre- and post-pause shows that equity factors — high dividend, low volatility, high quality, momentum value and small cap stocks — have historically delivered good relative returns through these transitions. Of course, with only six events, there was a wide dispersion of historical outcomes, reflecting the economic environments specific to those events. There’s no certainty that the coming year’s patterns will stick closely to the historical averages. However, a multifactor strategy, combining the equity factors listed above, may help by smoothing the volatility of individual factors, particularly considering the high dispersion in factor performance over the periods studied.

IMPORTANT INFORMATION

Northern Trust Asset Management (NTAM) is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

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