What Happens When the Punch Bowl is Taken Away?


Maybe some would say a good problem to have when considering where things were a year ago, but a primary risk to markets now is that the economy is overheating. We have made note of the inflation readings that have jumped meaningfully over the past several months, but why could this signal a risk for markets? Because it raises the possibility of Central Banks pulling back some of the stimulus which has helped support markets since last March. In response to the inflation jump Fed officials have been adamant about portraying the price spikes as transitory. But at the same time have begun to discuss the possible tapering of asset purchases leading many investors to bring forward their expectations for the first rate hike. In our view this will be the key source of volatility for markets in the second half of the year, particularly in August during the Feds annual Jackson Hole meeting where Chairman Powell is likely to signal a tapering of the Feds bond buying program.

While many investors view the relaxing of Fed policy as a harbinger of poor forward stocks returns, history shows that the market has remained fairly strong in the months leading up to and following the first rate hike (with increased volatility). In the last 4 rate hiking cycles (1994,1999,2004,2015) the S&P 500 has gained an average of 9.5% in the twelve months prior to the first hike, and 26% over the subsequent 3 years. When the real damage has come is later in the cycle when the Fed has tightened policy too far leading to a flattening/inversion of the yield curve. But right now that seems like a good distance off.


Commentary Disclosures: Covington Investment Advisors, Inc. prepared this material for informational purposes only and is not an offer or solicitation to buy or sell. The information provided is for general guidance and is not a personal recommendation for any particular investor or client and does not take into account the financial, investment or other objectives or needs of a particular investor or client. Clients and investors should consider other factors in making their investment decision while taking into account the current market environment.


Covington Investment Advisors, Inc. uses reasonable efforts to obtain information from sources which it believes to be reliable. Any comments and opinions made in this correspondence are subject to change without notice. Past performance is no indication of future results.

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Covington Investment Advisors, Inc.
301 E. Main Street
Ligonier, PA 15658
Phone: 724-238-0151
Fax: 724-238-0148
Email: covington@covingtoninvestment.com

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