The ongoing situation with Russia and Ukraine could affect U.S. and global growth because of the potential impact on the energy sector, Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., said in her latest market note, released Tuesday.
She asked investors to "excuse this longer-than-usual report." But she told readers to "consider it an 'encyclopedia' of sorts associated with the important shift underway in monetary policy" by the Federal Reserve.
"Unlike in advance of (or during) some past tightening cycles, the Fed is not operating with a pre-determined policy playbook" this time, according to Sonders.
"That said, Fed speakers — including Chair Pro-Tempore Jerome Powell — have a keen understanding of the power of their words, which have contributed to the tightening of financial conditions already underway," she said.
"What makes this cycle particularly unique — aside from the implications of the pandemic — is that the Fed plans to embark on a tightening cycle via raising the fed funds rate, while also planning to shrink a $9 trillion balance sheet," she pointed out.
Rate Hike Cycles
There are three kinds of rate hike cycles: slow, fast and "non," Sonders noted. "Slow cycles are when the Fed was raising rates over a span of time, but also taking its time by not hiking during consecutive months or Federal Open Market Committee (FOMC) meetings," she said.
On the other hand, "fast cycles — like between 2004 and 2007 — were when the Fed was raising rates during consecutive months or FOMC meetings," she said.
And "non cycles" were periods in which the Fed started increasing rates but had to stop after just one or two for many reasons, according to Sonders.
The S&P 500's performance during the lead-up to the initial hike in March has been "significantly stronger than the average of prior cycles, including both slow and fast cycles," she said. "Although fast and slow cycles historically had similar performance during the lead-in period, it was in the aftermath of the initial hike that a major divergence began."
Meanwhile, earnings and valuations are typically "key drivers of stock market returns, with some interesting trends occurring during past rate hike cycles," she pointed out. "Historically, the lead-in to fast cycles, as well as during the first year of rate hikes, were characterized by much stronger earnings growth … while that reversed once year two was underway."
Because of the "slowdown in earnings growth underway … the start of the coming rate hike cycle comes at a unique time," she noted. "In terms of valuation, a March initial rate hike would correspond to the second-highest S&P 500 P/E ratio in history. Historically, small cap stocks have been mixed vs. large cap stocks around the first rate hike."
Predictions
Below are five key predictions that Sonders made in the report.
1. The Russia-Ukraine situation won't stop the Fed from raising rates.
"Market volatility this year so far has both longer-term and shorter-term drivers, including the pending Federal Reserve tightening cycle and the Russia/Ukraine uncertainty, respectively," Sonders noted.
Although the Russia-Ukraine situation "could influence expectations around U.S. and global growth via the energy price channels, it likely won't lead to the Fed veering off its present course to begin raising interest rates, shrinking its balance sheet, and putting pressure on aggregate demand in order to rein in elevated inflation," she said.
