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Market correction ahead when Fed raises rates, says Klement

According to the monthly EIE Fund Manager Sentiment Survey, a majority of international asset management companies have been expecting US equity markets to generate losses in excess of 5% over the next 12 months. In a similar display of pessimism, sellers of US equities have been outnumbering buyers in almost every European country for the past year or so. And European investors have reduced their US equity holdings by more than €17bn in the first seven months of the year.

According to Klement, this all makes a lot of sense. He conducted a statistical analysis on the effect of the start of a Fed rate hiking cycle on stock market returns. Klement found that since 1960, every time the Fed started to hike rates this triggered a market correction (usually within a few months, though in the period 2005-2007 it took a couple of years), with the exception of the mid-1990s (see chart below). 

 

The curse of forward guidance

But this time around things may be different because the Fed has been consistently employing a very carefully designed policy of ‘forward guidance’. Therefore nobody will be caught by surprise if the Fed raises rates. Klement, however, is sceptical the Fed’s objective to avoid market panic is going to work.

Part of the Bonhill Group.