Don’t fight The Fed

Central banks have always played a major role in overall stock market sentiment. However, since the financial crisis of 2008, the world's largest central bank, the US Federal Reserve, has become more influential on the stock market than ever. So much so that many experts would advise you to adjust your investment strategy accordingly. "Don't fight the Fed" is an unvarnished warning that anyone who ignores developments surrounding the Fed risks financial adversity. But is that really the case?

In layman's terms

Countless investors, companies and savers around the world were hit hard by the 2008 economic crisis and its aftermath. To restore confidence in the market, the Fed played a guiding role in getting the stock markets back into the black. It suddenly started actively steering the market, for example by lowering interest rates and buying up bank bonds, even though its main job is actually to guarantee economic stability.

The Fed suddenly took the stock market reins, which turned out to be good news for the US stock market. Between 2012 and 2022, the S&P 500's average annual return grew by almost 14% rather than its usual historical 9 to 10%.

According to this stock market wisdom, you'd better listen when the US Federal Reserve makes a new interest rate announcement:

• If it is raising interest rates, this makes borrowing more expensive, which often leads to lower stock prices.
• If it is lowering interest rates or pumping money into the economy, this often creates a favourable climate for shares.

Who said it first?

Although this stock market adage is still very relevant today, the slogan was already popular back in the 1970s. It was the late Marty Zweig, a well-known American investment strategist, who linked the performance of the stock prices to general interest rates. He concluded that it was extremely difficult to invest against the direction of the Fed.

Is that really how the stock markets operate?

If you look at the Nasdaq and other Wall Street stock market charts between 2009 and 2022 and you compare them with the Federal Reserve's balance sheets, you cannot help but conclude that they look almost synchronised.

Many companies that placed their trust in the Fed during this period made huge leaps forward on the stock market. These included today's major tech players, such as Apple, Microsoft and Amazon. And you guessed it: as soon as it starts to rain on the American stock markets, the rest of the world had better get their umbrellas out too.

And suddenly interest rates plunged

The opposite scenario is also possible. In 2022, the Fed raised interest rates at record speed to curb rising inflation. This led to a sharp correction on the stock market. Investors who refused to believe that higher interest rates would have a major impact were proven wrong. The Nasdaq, for example, lost around 33% between the opening of the stock markets in January 2022 and the end of the trading year on 30 December 2022. It was its worst stock market result since... 2008.

Is it worth a try?

This wisdom serves as a reminder that, as an investor, you should never think you are stronger or smarter than the system. But what if you are one of those rebellious investors?

Expert insight: "Be sure to keep an eye on those Fed press conferences"

Danny Reweghs is a stock market analyst, Director of Strategy at Trends Beleggen, and (co-)author of the book 'Haal alles uit uw beleggingen' (Get the most out of your investments) and various other publications on this subject. He has been one of the most experienced voices in stock market analysis in Belgium for more than thirty years.

"The US Federal Reserve's influence on the financial markets should not be underestimated. And that in itself is a considerable understatement. As long as interest rates remained low between 2009 and 2022, the stock markets performed exceptionally well."

"Only when the Federal Reserve turns the tide, should you be on your guard, even as a Belgian or European investor. In concrete terms, don't fight the Fed means that as long as the Federal Reserve is pumping money into the system, shares can become more expensive and therefore more lucrative. But when its policy tightens, it is often better to wait a while before making new purchases or looking for opportunities to take profits."

"Today, the Fed's policy is once again somewhat tighter, especially after the recent inflation shocks. That is precisely why its interest rate meetings remain key moments for countless active investors worldwide. You can be sure that they are keeping a close eye on its press conferences. So, make sure you follow the Federal Reserve's policies closely and consider adjusting your strategy as soon as its changes direction."

The 2013 Taper Tantrum

When the Federal Reserve announced in 2013 that it wanted to taper its bond purchases, the markets panicked. Currencies and bond prices fell sharply worldwide, which had a particularly significant impact on many emerging markets.

This announcement once again confirmed the Fed's global impact and immediately triggered mechanisms to develop a more cautious communication policy in order to avoid such stock market reactions as much as possible in the future.

What should you bear in mind as an investor if you're just starting out?

If you are just starting out on the stock market or if you haven't found the right investment strategy yet and you think this stock market wisdom is worth exploring, we would like to summarise the possible strategies for you.

1. Follow the interest rates

Higher interest rates mean lower stock market appetite, and vice versa.

2. Learn to understand interest rate mechanisms better

The better you can interpret the interaction between interest rates and stock market prices, the more relevant context and knowledge you will gain as a novice investor.

3. Check the inflation figures

If there are rumours of inflation or signs of significant inflation, the Fed may intervene and raise interest rates.

4. Read the Fed meeting summaries

These may guide future policy decisions.

5. Be cautious with interest rate-sensitive sectors

Real estate, technology and growth companies often show a particularly strong response.

Gold rush in times of instability

Interest rate announcements by the US Federal Reserve may also have an impact on specific types of shares. Gold shares, for example, have been on the rise since 2023. Firstly, this is because gold is a safe investment in times of geopolitical instability. And secondly, signals from central banks such as the Fed also play a role.

When they cut interest rates – or even just hinting at doing so – gold suddenly becomes a very attractive option for investors. This is because physical gold is non-interest-bearing, unlike many other assets. Lower interest rates therefore make it cheaper for investors to hold gold. This causes demand for gold to rise among investors. One announcement from the Fed may therefore be enough to get the ball rolling.

From stock market wisdom to life wisdom

"Don't fight the Fed" is a friendly reminder that it is best to keep an eye on the bigger picture. Be aware of all the forces that can influence the markets. The good news? You don't have to be an experienced economist to learn to recognise trends. According to this stock market adage, sometimes it is enough simply not to swim against the tide.