- With the Fed likely to begin raising interest rates next year, investors are bracing for impact.
- Stock market investors have been conditioned to believe equities perform poorly when the Fed hikes rates.
- But the stock market has only had two losing years in the last 30 when the Fed raised rates, according to DataTrek.
Investors have been conditioned to believe that the stock market performs poorly when the Federal Reserve hikes interest rates, as a jump in the cost of capital can hurt the financial profile of long-duration assets like growth stocks. But the data tells a different story.
According to DataTrek Research, the S&P 500 has only had two losing years since 1990 when the Fed was raising interest rates: a 9% decline in 2000 and a 4% drop in 2018. That leads the firm to believe that investors need not be concerned about the Fed’s likely start of interest rate hikes sometime next year.
“There are plenty of reasons to be skittish on US large caps (valuation chief among them) but Fed rate hikes aren’t at the top of our list,” DataTrek co-founder Nicholas Colas said in a Friday note.
Fed funds futures currently show a more than 75% chance of an interest rate hike late next year, according to the CME’s FedWatch Tool. Those probabilities soared earlier this month after consumer price data showed inflation hitting its highest rate since 1990.
But as prior cycles of tightening show, “it is very unusual to see US large caps decline when the Fed is raising rates,” Colas said.
Periods of rate hikes occurred twice in the 1990’s, once in the 2000’s, and once in the 2010’s. The S&P 500 delivered a positive compound annual growth rate of 17.9%, 10.3%, and 9.2% in those decades, respectively, according to the note.
The lesson from the past 30 years, Colas said, is that stocks tend to fall when the Fed overtightens financial conditions, like it did in late 2018.
“That may happen at some point in the upcoming Fed rate cycle, which markets believe will begin next summer, but certainly not right off the bat,” he added. That’s because the Fed Funds rate is at a rock-bottom range of 0% to 0.25%, and it will take multiple 0.25-percentage-point increases before interest rates are no longer considered “historically low.”
In other words, stocks can withstand several rate hikes from the Fed, especially when the underlying economy is still growing, and higher rates aren’t reason enough for investors to sell their stocks, according to DataTrek.