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Are Fed Rate Hikes Bad for the Stock Market?

The stock market has been in a holding pattern, waiting to see what Janet Yellen will say on Friday. Recent history suggests investors are rooting for the wrong outcome.

Recently, investors have been subjected to an onslaught of news concerning the Fed and interest rates. And tomorrow morning is the main event: Fed Chairwoman Janet Yellen will speak at Jackson Hole, Wyoming and is expected to throw in her two cents on what the Fed should do.

What’s an investor to make of it all? Well, we’re all told that the Fed’s moves greatly impact the stock market—that all things being equal, rate hikes are bad for the market while rate cuts (or quantitative easing) are good for the market. Back in the 1980s and 1990s, that was in fact the case.

However, the Fed’s moves in recent years haven’t had the same effect. The script has been flipped—rate hikes tend to lead to higher stock prices—while rate cuts coincide with major declines!

Let’s take a look.

The Fed’s first rate cut following the popping of the Internet bubble was in January 2001. The S&P 500 did rally decently (see chart) in January but then imploded in February and March and was plunging to lower lows even before the 9/11 attack. All told, the S&P 500 fell 40% from that first rate cut to its bear market low in July 2002!

After the bear market ended for good in March 2003, the first Fed rate hike didn’t come until June 2004. The stock market faded for the following six weeks, but began ripping higher in October (this was when Apple (AAPL) began its monstrous run) and had a big rally into 2005. The ultimate top wasn’t until 2007, with the S&P 500 up 40% since that first rate hike.

The next round of rate cutting started in September 2007 … more than a month before the horrific bear market began! Once again, there were some short-term good vibes but then the market collapsed into March 2008. Amazingly, the stock market decline from that first rate cut to the bear market low in March 2009 also ended up being around 40%.

Obviously, three examples don’t make a comprehensive study, but my point is that for the past 16 years, all the (over) analysis of the Fed hasn’t helped investors make money. I’m not saying you should ignore the Fed, but that you’re better off sticking with the market’s evidence.

One (tongue-in-cheek) final note: I was shocked to see that the stock market ended up moving 40% from the time of the Fed’s first move to its ultimate high or low in each example. If that pattern holds (a mountain-sized “if” given that we’re talking about only three occurrences), the S&P 500 should rise from about 2,040 (when the Fed first hiked rates last December) to north of 2,800 before this bull run is over. I’m all for that!

Short term, anything is possible—I wouldn’t be shocked if the stock market dipped for a few days, possibly on some “bad” Fed news.

But all of my market timing indicators remain clearly positive, so I continue to expect higher stock prices.

One stock idea that I like today is more cyclical than I usually go for. But with a top-notch CEO and the business just reaching a major tipping point, I think it can do very well in the months ahead.

It’s XPO Logistics (XPO), which I wrote about in Cabot Top Ten Trader two weeks ago:

“XPO Logistics’ story all starts with CEO Bradley Jacobs, who has a history of taking a small company, aquiring dozens of small fish in a fragmented industry, and selling the combined company for huge returns years later. He’s done it in energy brokerage, waste management and heavy equipment rentals. Now he’s up to his old tricks with XPO Logistics, a transportation logistics firm, in which he bought a majority stake in 2011. (XPO is a leader in freight brokerage, last-mile logistics, contract logistics, intermodal and more.) Since then, Jacobs has done a ton of buyouts, including a move into the trucking industry itself with a $3 billion purchase of Con-way last year. The company’s constant expansion caused losses to grow; combined with the horrid market late last year, investors bailed out in a big way. But now, the stock is looking much better, thanks mainly to a blowout earnings report—in Jacobs’ words, the results ‘confirmed that we’re at a positive inflection point in the evolution of our business.’ That mainly means that after years of gobbling up firms, XPO is now starting to crank out a ton of cash—in the second quarter, earnings leapt into the black and crushed estimates, free cash flow was solidly positive, and the company bumped up its guidance for the rest of the year. Analysts now see earnings of nearly $1.70 per share next year, and Jacobs has a 2018 target of at least $1.7 billion of EBITDA as he works on efficiency measures. Long-term, there’s not a ton of growth here; most of XPO’s businesses are growing organically in the single digits. But this story is about Jacobs’ ability to morph the company into a big leader in the transportation field, and the second-quarter report says that he’s well on his way.”

XPO has traded tightly since catapulting to multi-month highs on earnings two weeks ago. I like the potential but as always, proper entry points and position management are key.

For my latest advice on XPO and new growth stock leadership ideas every week, consider giving Cabot Top Ten Trader a try. I’m offering a low price for new subscribers when you sign up now!

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A growth stock and market timing expert, Michael Cintolo is Chief Investment Strategist of Cabot Wealth Network and Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader. Since joining Cabot in 1999, Mike has uncovered exceptional growth stocks and helped to create new tools and rules for buying and selling stocks. Perhaps most notable was his development of the proprietary trend-following market timing system, Cabot Tides, which has helped Cabot place among the top handful of market-timing newsletters numerous times.