The stock market typically bottoms out before the end of a Fed rate hike cycle. Here’s how to make that bet pay off.

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A lot of money can be made betting on when the Federal Reserve will “turn around” — that is, take its foot at least partially off the accelerator for the rate hike. However, a lot of money can also be lost, as we saw on August 26 when the Dow Jones Industrial Average DJIA,
-0.57%
lost more than 1,000 points after Fed Chair Jerome Powell dashed hopes that the Fed’s pivot had started in July.

So it’s helpful to review past cycles of rate hikes to see how investors fared as they tried to anticipate when those cycles would come to an end.

To do that, I focused on the six different rate hike cycles since the Fed started targeting the Fed fund rate specifically. The table below shows how many days before the end of those cycles the stock market bottomed out. (In particular, I focused on a six-month period leading up to the end of each cycle, determining when within that period the S&P 500 SPX,
-0.67%
hit rock bottom.)

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Start of rate increase cycle

End of rate hike cycle

Days before the end of the cycle, the S&P 500 bottomed out

S&P 500 profit from low to end of rate hike cycle

S&P 500 Profit 3 Months After Market Low

S&P 500’s gains 6 months after the market bottom

S&P 500’s gains 12 months after the market bottom

30-Mar-83

9-Aug-84

16

+12.0%

+13.2%

+18.7%

+30.3%

4-Jan-87

24-Feb-89

176

+11.1%

+5.5%

+12.7%

+36.0%

3-Feb-94

1-Feb-95

55

+5.6%

+9.9%

+18.5 %

+38.3%

29-jun-99

May 16-00

81

+10.0%

+3.6%

+13.1%

-4.9%

29-jun-04

29-jun-06

16

+4.0%

+7.3%

+15.5%

+24.5%

15-dec-15

20-dec-18

0

+0.0%

+13.4%

+19.4%

+30.6%

AVERAGE

57

+7.1%

+8.8%

+16.3%

+25.8%

As you can see, the market bottomed out on average 57 days before the end of the Fed’s rate hike cycle – about two months. But also note that there’s quite a range, from no lead time at one extreme to almost the entire six-month window I’ve been focusing on. Since it’s hard to know when the Fed will actually kick in, this wide range illustrates the uncertainty and risks associated with trying to reinvest in stocks in anticipation of a pivot.

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Nevertheless, the table also shows that there are big profits to be made if you get it even partially right. For example, the S&P 500 gained 7.1% on average over the period between the market’s pre-pivot low and the actual end of the rate hike cycle. That is an impressive return for a period of two months. In addition, the average gain over the six months after the pre-pivot low is a strong 16.3%, and over the 12 months after that low it is 25.8%.

How should you play this risky/high reward situation? One way is to average the dollar cost to what your desired equity exposure is. For example, you could divide the total amount you ultimately want to put back into the stock market into five tranches and invest each tranche in stocks at the end of the next five calendar quarters. If you took this approach — and it’s just one of many possible — you’d be back to your target equity exposure by early 2024.

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Such an approach will not bring you in stocks to the exact pre-turn low, but hoping for that is delusional. Still, the approach should get you an average buy-in price that’s better than waiting. It should also protect you from days like August 26, when the market punished those who bet the Fed had already started spinning.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings keeps investment newsletters that pay a fixed fee to be audited. He can be reached at [email protected]

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