The upcoming two day Federal Reserve meeting that concludes September 17th seems to have investors on edge. The million dollar questions is whether the Fed will raise rates or not. If one is a stock investor, they should hope the Fed raises rates and puts this extended anticipation to rest. Another reason investors may want to see the Fed raise rates is due to the positive impact a rate increase has on equity prices.
As we noted in a post last month, Anticipating The Rate Hike, initial Fed rate increases tend to not have a negative impact on equity prices. Further evidence can be seen in the below chart. The red dots on the S&P 500 Index chart line denote the first rate hike in a Fed tightening cycle. The yellow line represents the yield curve (30 yr treasury minus 3 month treasury bill) and one can see why investors focus on equity performance when the yield curve inverts.
As the red dots clearly show, the onset of a tightening cycle isn’t necessarily a precursor to poor equity market performance. In our earlier article link above, we provide a magnified look at equity market performance around this initial rate hike period. Equities do tend to exhibit weakness initially; however, the weakness tends to be short lived.
S&P Dow Jones Indices recently released a report, What Rising Rates Will Not Do, that also examined equity returns in rising interest rate environments. The below chart included in the report shows the S&P 500 Index return during rising rate periods. The shaded area represents rising 10 year yields and clearly a rising 10-year treasury yield has not been a negative for stock returns.
Source: S&P Dow Jones Indices
Breaking down returns by month, S&P notes,
“Furthermore, between January 1991 and June 2015, the average monthly return for the S&P 500 was 0.88%. Paradoxically, in the four periods of rising rates, the average monthly return was 1.26%, compared with an average monthly return of 0.73% for the periods of declining rates. Rising rates have clearly not been bad for stocks over the past two decades (emphasis added.)”
For more insight into equity returns during these tightening cycles, our article a few years back, Rising Interest Rates Can Be Good For Stocks, provides a table outlining equity returns over various cycles going back to 1973. It seems the Fed has missed an opportunity to increase rates as far back as a year ago; however, a lift off in September doesn’t mean stocks are a poor investment over a complete tightening rate cycle. Certainly, stocks are likely to experience more volatility around this initial lift off period, but can move higher after the beginning of the rate increase cycle.
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