History shows equities can ride out the rate hike cycle

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An eagle tops the facade of the Federal Reserve Building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

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NEW YORK, March 16 (Reuters) – Fears over the Federal Reserve’s hawkish turn have combined with geopolitical uncertainty to push the S&P 500 into a correction this year, but historical data suggests the policy tightening money has often been accompanied by strong gains in equities.

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

The S&P 500 returned an average of 7.7% in the first year the Fed raised rates, according to a Deutsche Bank study of 13 hike cycles since 1955.

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An aggregate analysis of 12 rate hike cycles by Truist Advisory Services found that the S&P 500 posted total return at an average annualized rate of 9.4% over the duration of those cycles, showing positive returns in 11 of those cycles. periods.

“Stocks have typically risen during periods when the fed funds rate is rising, as this is normally associated with a healthy economy and rising earnings,” Truist co-chief investment officer Keith Lerner wrote in a report. .

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However, many investors fear this year will be more complicated than most as markets face runaway inflation which is likely to be aggravated by soaring commodity prices following the war between Russia and Ukraine.

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

Admittedly, rate hikes have tended to weigh on equities in the short term. An analysis by Evercore ISI of four up cycles found that the S&P 500 fell an average of 4% in the first month after the start of the cycle.

But the benchmark 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 usually takes a lot of walking before the economy is set up to potentially feel a recession,” said Julian Emanuel, senior managing director of Evercore ISI.

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

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However, as the Fed begins to tighten monetary policy after offering massive support to help the economy weather the coronavirus pandemic, some investors are braced for possible instability.

The S&P 500 slid more than 10% at the start of 2022, while the tech-heavy Nasdaq (.IXIC) confirmed that it was in a bear market, falling more than 20% from its historic high in November. Technology and growth stocks underperformed as rising bond yields put pressure on the value of future cash flows on which these stocks’ valuations are based.

Six-month performance of RLV vs RLG

Morgan Stanley equity strategist Michael Wilson said if the Fed “succeeds in orchestrating a soft landing” for the economy by raising rates this year, it could lead to much higher bond yields, which ” would simply weigh on stock valuations.”

“Ultimately, the Fed is going to start pulling the punch bowl out this week,” Wilson said in a note this week.

“The question for equity investors is how far can they go with rate hikes given already slowed growth and the added shock of war?”

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Reporting by Lewis Krauskopf; edited by Richard Pullin

Our standards: The Thomson Reuters Trust Principles.

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