“Don’t Fight the Fed” is an old market cliché that was very applicable during the longest bull market in US history. It is also very applicable currently as the Fed implemented policies to slow the economy by raising interest rates and selling assets from its balance sheet. ~ Chris Vermeulen, Seeking Alpha

In 1977, the US Congress officially gave the Federal Reserve a multi-part mandate to maximize employment, maintain prices near an acceptable inflation target of around 2%, and moderate long-term interest rates. In general terms, Fed policies are supposed to stimulate the economy when it’s weak and cool it when it’s too hot.

The adage highlights the strong correlation between Federal Reserve policy and the direction of the stock market.

“Don’t Fight the Fed” embodied the sentiment that if the Fed was stimulating the economy with accommodative policies, it made little sense to bet against the market’s bullish trend. Effectively, when the Federal Reserve’s monetary policy is loose, markets tend to move higher, volatility is subdued, and investors’ risk is limited, so it makes sense to stay invested and ride the wave. Why “fight the Fed” by selling stocks when it’s on your side?

The Fed held interest rates near zero and instituted a policy called quantitative easing—where it bought mortgage-backed securities and U.S. Treasuries to increase the money supply in hopes of spurring lending and capital investment.

When the Federal Reserve is on a mission to slow the economy down in order to tap down inflation, technology and growth stocks are generally hurt as the cost of capital and borrowing money increases. Thus, the old adage, “Don’t fight the Fed” becomes an important one for investors to abide.

With inflation being persistent in the U.S., Fed officials have taken a new monetary stance that is far less appealing for investors.

The Fed is in Quantitative Tightening mode and has raised interest rates and sold assets from its balance sheet. This calendar year, the Fed has raised interest rates four times and has begun shrinking its balance sheet after years of quantitative easing pushed its holdings to nearly $9 trillion. Its intent is to cool the economy and reduce inflation.

The adage, “Don’t fight the Fed”, is a warning to avoid stocks, or at least to take a more conservative approach to investing.

As a result, investors should take a more cautious approach in this tightening environment and prioritize defensive stocks with pristine balance sheets and steady revenue growth that can survive inflationary pressure.

Inflationary economies tend to punish unprofitable technology and growth companies, despite their potential. Without profits or cash flow, it’s simply too hard to improve quarter over quarter at a time when money becomes more expensive to borrow.

References:

1. https://www.fortunebuilders.com/best-stocks-to-buy/
2. https://fortune.com/2022/09/14/dont-fight-the-fed-new-meaning-inflation-economy-dan-niles-satori-fund/amp/
3. https://seekingalpha.com/article/4544537-dont-fight-the-fed