The hints of a Fed rate hike have been fairly constant since before the year started. The earliest guesses wrongly put the hike in June. Some have said September. The reality is nobody knows. It’s that uncertainty that gets people worrying about how it will impact their portfolio.
The funny part about all this is people have complained about low rates for six years. Now people are worried about getting what they wanted. But at what cost?
A bump up in rates is bound to have some effect because interest rates play a big role in the economy from the cost of borrowing money, to valuing stocks and bonds, and finally how you make investment decisions.
To find out the impact, I found the date of the initial rate hike thanks to the historical Fed funds rate data at the New York Fed (the data only goes back to 1971). I broke down the S&P 500 performance following the initial Fed rate hike from three months to two years.
|Stock Market Performance (S&P 500) Following Initial Fed Rate Hike|
|Initial Rate Hike||3 mo Returns||6 mo Returns||12 mo Returns||24 mo Returns|
There were eleven Fed rate hike cycles since 1971. The table shows the outcomes ranged from a decent loss to a solid gain depending on the period, but overall averages tend toward the low side compared to average stock returns. Simply, higher rates don’t guarantee immediately higher returns.
You should keep in mind that interest rate moves play a role in the stock market’s performance, but it’s only one of many factors driving prices. It seems silly to base investment decisions on rates alone, especially when so little is known.
Here’s what we don’t know. We don’t know when or how much the initial Fed rate hike will be. We don’t know if it will be followed by a long period where nothing happens or if it’s the start of a gradual rise over several months. And I doubt the Fed knows either until the decision is made. So it’s understandable investors might not want to deal with that uncertainty.
I think any fear of a rate hike is more telling than the actual rate hike itself. Those that are afraid of it seem to have their mind made up already. Get enough of those people together and who knows what could happen.
And that’s the point. Nobody knows whether the entire event ends as a grand spectacle or a dud because the market regularly creates drama where there is none. When the smoke clears interest rates will be a little higher, which is all we do know.
You can take advantage of any opportunity if it arises or you can do nothing (most of you are better off doing the latter because the opportunity won’t seem like much of an opportunity at the time).
So you can spend a lot of energy trying to figure out what the Fed doesn’t even know just to place a bet. Or you can spend that energy on an investment strategy that doesn’t rely on you guessing when and where interest rates go next.