A 'pause and pop' rally will push stocks higher throughout 2023 as the Fed backs off aggressive policy, CFRA says

• Stocks look ready for a 'pause and pop' between when the Fed pauses rate hikes and starts cutting, CFRA said.
• Financial and homebuilding sectors historically perform best during the nine-month stretch between the Fed's actions.

The Federal Reserve will unleash a "pause and pop" rally in the stock market when policy makers halt their interest rate hikes then shift to cutting down borrowing costs, according to CFRA.

The independent research firm said Monday it believes the Fed's rate hike on February 1 will be the last in its aggressive cycle that started from zero percent last year. Such a move would mark the Federal Open Market Committee's eighth consecutive rate increase and would leave the Fed funds rate at a range of 4.5%-4.75%.

"Historically, the FOMC has started a new rate-easing cycle an average of nine months after the last rate hike. Should history repeat, the FOMC could start cutting rates toward the end of 2023, or early in 2024," Sam Stovall, CFRA's chief investment strategist, said in a note.

The nine-month gap between a Fed pause in rate hikes and the first interest rate cut usually results in a gain for the S&P 1500 index, he said. Data that run back to 1995 show 99% of S&P Global sub-industries on the S&P 1500 posted average price increases.

The top-performing sectors have been the financials and real estate groups, rising 22.5% and 20.1%, respectively. Materials and energy also move higher, but at smaller respective paces of 9.3% and 8.3%.

The best sub-industry has been homebuilders with an advance of 36.6%, with CFRA calling homebuilder Lennar a representative company in that group as it's had the highest return.

Gold, meanwhile, has been the worst-performing subindustry with a loss of 7.1%.

Stovall said CFRA apparently not alone in thinking the Fed is on the verge of pausing rate hikes, outpointing the S&P 500's nearly 5% rise since the start of 2023. The S&P 1500 also risen nearly 5% during January.

"Will investors sell on the news, or continue pushing share prices higher? If history is any guide, for it is never gospel, prices will likely head higher," he said.