Monday, January 19, 2015

rising interest rates and the stock market

[1/19/15] When you examine previous periods in which interest rates have risen and you look at, say, the S&P 500's return during those time periods, what you tend to see is that stocks tend to behave reasonably well during those periods. The key reason is that the stock market is responding mainly to the economic growth that is often precipitating those interest-rate increases. So, that's the main thing that the stock market will respond to--secondarily will be what's going on with rising rates. Of course, how this particular rising-rate environment will unfold is anyone's guess; but when you look over past historical periods, it hasn't been a terrible period for stocks when interest rates have been on the move upward.

Stipp: Lastly, when we do see rates go up, historically something else is usually going up and that's inflation. So, you might be getting a higher rate on some of your fixed-income investments, but you might also be paying more at the grocery store or at the gas pump.

Benz: That's right. So, when interest rates are on the move, it's often when the economy is performing well and inflation is often on the move at that time. So, what the market gives with one hand in the form of higher yields, it may be taking away with the other in the form of inflation. Think back to the period in the mid-80s, for example, when inflation was at a very high level. Yields were very, very high at that point, too; but inflation really was tamping down investors take-home yield because of those higher prices.

[9/24/14] The debate now is over when the rate hike will happen in 2015 -- spring or summer. It's a foolish discussion and impossible to predict, even for people whose livelihood depends on calling Fed turns and market tops.

What’s more important is what the markets will do when the Fed finally gets around to boosting short-term rates and returning them to "normal," whatever that means.

Well, actually, it's more about what will happen before and after rates start rising, because the stock market, as we know, anticipates big economic changes like rate hikes and recessions months ahead.

And there, market history suggests long-term optimism but short-term caution.

Sam Stovall, S&P Capital IQ's U.S. equity strategist, recently tracked Fed interest rate hikes going back to the end of World War II.

"In 13 of the 16 times the Fed raised rates, the market went into a pullback, correction or bear market" in the six months before the rate hikes began, he told me in a phone interview last week.

In the years since 1946, Stovall found six pullbacks (a 5 percent to 10 percent decline), four corrections (when stocks fell from 10 percent to 20 percent) and three bear markets (a drop of 20 percent or more) began in the six months before the Fed started tightening. He used the S&P 500 Index for his research.

The S&P 500 lost 16 percent of its value, on average, during those declines, but it fell slightly less in the six months after rate hikes began.

"We had pullbacks, corrections and bear markets start more often in the six months before [a rate increase] than the six months after," he told me.

Altogether, Stovall wrote last week, "88 percent of the time, the markets were thrown into a pullback or worse when an initial rate hike was a possibility or reality." That means "a very high likelihood that the S&P 500 will begin a decline of 5 percent or more within six months" of the Fed's first hike.

Sounds depressing. Yet if you look at the numbers somewhat differently, the S&P 500 "was back in the black and up an average 1.3 percent" within six months after the first rate increase, Stovall wrote.

The point is that although the prospect of a new Fed rate-tightening cycle brings out the fear in investors' reptilian brains -- and even the great Marty "don't fight the Fed" Zweig believed in selling on the Fed's second rate increase -- it need not lead to long-term losses.

In fact, that fear may cause investors to sell way too early when waiting it out would be a better strategy. It usually is.

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