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History shows stocks can weather rate hike cycle

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© Reuters. FILE PHOTO: An eagle tops the Federal Reserve building’s facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Lewis Krauskopf

NEW YORK (Reuters) – Fears over the Federal Reserve’s hawkish shift have combined with geopolitical uncertainty to push the S&P 500 into a correction this year, yet historical data suggests tighter monetary policy has often been accompanied by solid gains in stocks.

That offers a glimmer of good news to investors, who widely expect the central bank to announce the first interest rate increase in more than three years on Wednesday and are pricing some 180 basis points of tightening by the end of the year.

The S&P 500 has returned an average 7.7% in the first year the Fed raises rates, according to a Deutsche Bank (DE:DBKGn) study of 13 hiking cycles since 1955.

An analysis of 12 rate hike cycles overall by Truist Advisory Services found the S&P 500’s posted a total return at an average annualized rate of 9.4% during the length of such cycles, showing positive returns in 11 of those periods.

“Equities have generally risen during periods where the Fed funds rate is rising because this is normally paired with a healthy economy and rising profits,” Keith Lerner, Truist’s co-chief investment officer, wrote in a report.

Title: U.S. stock market during rate hike cycles, https://graphics.reuters.com/USA-STOCKS/FED/lbpgnzabbvq/chart.png

Many investors worry that this year may be more complicated than most, however, as markets are faced with soaring inflation which stands to be worsened by surging commodity prices in the wake of Russia’s war with Ukraine.

The uncertainty has presented a dilemma for the central bank, with some investors worried policymakers could push the economy into a recession if it raises rates too far as it seeks to tamp down inflation.

To be sure, rate increases have tended to weigh on stocks in the near-term. An analysis by Evercore ISI of four hiking cycles found that the S&P 500 fell an average of 4% in the first month following the start of the cycle.

But the benchmark index was higher six months into the cycle by an average of 3%, and 5% higher on average after 12 months, according to Evercore.

“The Fed doesn’t want a recession and it generally takes a whole lot of hiking before the economy is put into position to potentially feel a recession,” said Julian Emanuel, senior managing director at Evercore ISI.

Emanuel said Evercore’s “base case” is that the market is “really in the midst of making a near-term bottom that is more likely to deliver the kind of six- and 12-month returns that a typical Fed rate hike cycle has engendered previously.”

Title: Stock performance as the Fed starts to hike, https://graphics.reuters.com/USA-STOCKS/FED/klpykbwkjpg/chart.png

However, with the Fed starting to tighten monetary policy after offering massive support to help the economy endure the coronavirus pandemic, some investors are prepared for potential rockiness.

The S&P 500 has slid more than 10% to start 2022, while the tech-heavy Nasdaq confirmed it was in a bear market, dropping over 20% from its November all-time high. Tech and growth stocks have underperformed, as the rise in bond yields pressures the value of future cash flows that those stocks valuations’ rely on.

Title: Growth underperforms value, https://fingfx.thomsonreuters.com/gfx/mkt/zgpomzgjmpd/Pasted%20image%201647373431666.png

Morgan Stanley (NYSE:MS) equity strategist Michael Wilson said that if the Fed “is successful in orchestrating a soft landing” for the economy as it raises rates this year, it could lead to much higher bond yields, that “would simply weigh on equity valuations.”

“The bottom line is the Fed is going to start removing the punch bowl this week,” Wilson said in a note this week.

“The question for equity investors is how far can they get on rate hikes given the already slowing growth and additional shock from the war?”

History shows stocks can weather rate hike cycle

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