The stock market usually falls before the end of a Fed rate hike cycle. Here’s how you can make that bet pay off.

A lot of money can be made betting on when the Federal Reserve will “pivot” — that is, at least partially take the interest rate hike pedal off. However, a lot of money can also be lost, as we saw on August 26 when the Dow Jones Industrial Average DJIA,
-0.68%
lost more than 1,000 points after Fed Chairman Jerome Powell dismissed hopes that the Fed’s pivot had begun in July.

So it’s useful to review past rate hike cycles to see how investors have fared when trying to predict when those cycles will end.

To do this, I focused on the six different rate hike cycles since the Fed began specifically targeting the fed funds rate. The table below shows how many days before the end of these cycles the stock market bottomed. (Specifically, I focused on a six-month window before the end of each cycle and determined when within that window the S&P 500 SPX,
-0.90%
reached its lowest point.)

Start of rate hike cycle

End of rate hike cycle

Days before the end of the cycle the S&P 500 hit its lows

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

S&P 500 Gains 3 Months After Market Low

S&P 500 Gains 6 Months After Market Low

S&P 500 gains 12 months after market low

30-March-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 hit its lows an average of 57 days before the end of the Fed rate hike cycle — about two months. However, also notice that there is a wide range, from zero lead time at one end to almost the entire six month timeframe I focused on. Since it’s hard to know when the Fed will actually start to pivot, this wide range shows the uncertainty and risk associated with trying to reinvest in stocks in anticipation of a pivot.

However, the table also shows that there are big profits to be had if you get it even partially right. For example, the S&P 500 gained an average of 7.1% in the period between the low before the market turn and the actual end of the rate hike cycle. This is an impressive performance over a two-month period. Furthermore, the average gain in the six months following the pre-pivot low is a robust 16.3%, and in the 12 months following this low is 25.8%.

How should you play this high risk/high reward situation? One way is to dollar cost average up to what you wish to put in stocks. For example, you could divide the total amount you want to eventually put back into the stock market into five installments and invest each installment 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.

Such an approach won’t get you into stocks at the exact pre-turn low, but hoping for that is a delusion. However, the approach should give you an average purchase price that is better than waiting. It should also protect you from days like August 26, when the market punished those who bet that the Fed had already started to pivot.

Mark Hulbert is a regular MarketWatch contributor. Its Hulbert Ratings tracks investment prospectuses that pay a flat fee to be reviewed. You can reach him at mark@hulbertratings.com

More: Learn how to get your financial routine in order at the Best New Ideas in Money Festival on September 21st and 22nd in New York. Join Carrie Schwab, president of the Charles Schwab Foundation.

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