- The Fed looks more likely to raise rates in the first half of 2015.
- The start of monetary tightening isn’t necessarily negative for stocks.
- But rising interest rates will likely dampen interest-sensitive sectors.
By Rick Golod
About the Mid-Year Review series: I've been examining some of investors' main concerns about the current economic and market conditions, many of which are detailed in my July commentary, "Mid-Year Review: Six Investor Concerns That Aren't Worth Losing Sleep Over." I will be addressing additional investor concerns on my blog.
With the recent strength in the economy and decline in the unemployment rate, the probability that the Federal Reserve (Fed) increases rates in the first half of 2015 is rising, in my opinion. Given the volume of media noise about this, it's understandable that many investors are still worried about the stock market's potential for correction.
To help keep perspective, remember that:
- Monetary tightening is usually warranted because economic growth is gaining momentum. A more positive economic backdrop benefits corporate earnings.
- Monetary policy works with a lag. In other words, some parts of the economy won't feel the effect of higher interest rates immediately, while others are more rate-sensitive.
- The upcoming rate-hike cycle will begin from an extremely low level of interest rates.
Therefore, you can see why historically the start of a rate hike isn't necessarily a negative for the equity market:
- The beginning of a rate hike cycle has rarely ended an equity bull market. Rather, most bull markets end in recessions. In the past, recessions have commenced, on average, 24 months from the first rate hike.1
- Corporate profits tend to increase at an above-average rate both prior to the start of the tightening cycle and up to five quarters after the first rate hike.1
- As detailed in my June 25 blog, "What Happens to Stocks When The Fed Hikes Rates?" in the past, when the Fed was tightening and the dollar was strengthening, the equity market tended to rise, as it did in the 1988/1989, 1997 and 1999/2000 periods.2
If Fed guidance remains clear and the dollar continues its upward trend, I don't anticipate the violent market correction that some forecasters are predicting. However, stocks with greater interest-rate sensitivity, such as real estate and utilities, are likely to correct as investors move from these sectors into more cyclical sectors (such as financials, industrials, energy).
- Ned Davis Research Inc., July 10, 2014
- Cornerstone Macro LP, April 2, 2014
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The financial, industry and energy sectors are more volatile than those of more diversified investments.
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