There have been seven bear markets over the last 43 years. The Federal Reserve has played a part in most, if not all, of those bear markets.
Before looking at the bear markets themselves, let’s look at the impact of Fed policy on the 10-year Treasury Note. During the inflation-wracked 1970s, the central bank of the United States embarked on three separate campaigns to combat the ever-escalating costs of living. Across three different tightening cycles that began at the start of three different presidencies – 1972, 1976 and 1980 – the yield traveled north of 14%.
Unfortunately, neither the tightening cycle that began in 1972 nor the one that began in 1976 did much to contain the soaring costs of products and services. Living standards suffered. Economic output waned. In essence, the U.S. struggled through stagflation – a period with rapidly declining purchasing power and anemic economic growth.
The third and final campaign to beat inflation back (1980) proved successful, if only due to the sheer scope of the endeavor. The recently appointed chairmen, Paul Volcker, sent the federal funds rate to a record high of 20 percent in late 1980. Car buying and home purchases became virtually non-existent because the cost to borrow money had journeyed through the proverbial roof. Meanwhile, the 1981-1982 recession did not sit well with politicians let alone businesses or consumers. For that matter, the third bear market in less than a decade had all but destroyed investor faith in Fed “shenanigans.”
When it comes to investing implications, then, one can should take note that rate hike campaigns to battle runaway inflation have led to sharp bearish retreats in equity prices. Most notably, in each of the 70s-style tightening cycles, bear markets began in a matter of months, not years. (See the initial three tightening cycles in the above chart.)
In the last three decades, however, a dramatically different Federal Reserve began to unfold. Whereas the Fed once agreed to a “dual mandate” for fostering stable prices and full employment, the entity’s singular prescription for meeting its goals has been the expansion of credit. In fact, nearly all of our economic growth over the least 30 years is attributable to the ability of consumers, businesses and government to borrow increasing amounts at lower and lower rates.
Revisit the chart above which chronicles the 10-year’s travels since 1984. Back then, it dropped from the 10%-plus level down to the 7% level, boosting stocks rather dramatically in the years where those borrowing costs were falling precipitously. (It did not hurt that inflation descended substantially in that time as well). Then came the December 1986 tightening cycle which sent the 10-year back up toward 8%. The fear of higher borrowing costs had a great deal to do with the 36.1% decline in stock prices as well as the Black Monday Crash on 10/19/1987.
Clearly, easy money Fed policy through decreasing the cost of credit has helped send the 10-year yield plummeting over the years – from 8% to 6% to 4% to 2%. Even the popular phrase “Don’t fight the Fed” tends to inspire risk taking whenever the Fed is employing conventional or unconventional measures.