Monday, August 23, 2010

rising rates and the stock market

With core inflation in the U.S. at its lowest level in decades and concern over the economic impact of the credit crisis in Europe, the Federal Reserve may continue the holding pattern that has been in place since December 2008 into next year before raising interest rates.

Whether interest rates begin rising this year or next, many equity investors are already concerned that a shift toward higher rates from such exceptionally low levels might derail a market recovery.

Historically, periods of rising rates have been associated with poor equity performance. But this is not always the case, particularly when rates are just beginning to rise after recessions.

... It is not that unusual, however, for stocks to perform well at least in the early stages of rising rate cycles because “investors are more comforted by improving economic fundamentals and corporate earnings than they are worried about rates at that point,” says Brian Rogers, T. Rowe Price’s chairman and chief
investment officer.

“A rising rate environment tends to be negative for stocks later in the cycle when the Fed tries to slow the pace of economic growth to ease inflationary pressures. That’s probably an issue for 2012 or later.”

Also, the initial rate hikes will comein the wake of the worst financial crisis since the 1930s, so Mr. Rogers adds, “Investors will be relieved because it will signal improving economic conditions globally.”

Indeed, in the nine instances since 1954 when the Federal Reserve first raised the federal funds rate following a recession, the S&P 500 Index recorded an average gain of almost 14% in the subsequent 12 months, rising in all but one of these periods.

-- T. Rowe Price Report, Summer 2010

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