Outperforming The Market While The Fed Is On Hold

Nov. 20, 2021 1:18 AM ETFCNTX, FLPSX, NAESX, PRISX, VB, VGSIX, VGSLX, VIGAX, VIGRX, VIVAX, VNQ, VSMAX, VTI, VTSAX, VTSMX, VTV, VUG, VVIAX2 Comments
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Tom Madell
1.53K Followers

Summary

  • Since March 2020, Fed short-term rate policy has been on hold and stocks have soared.
  • Such prior "on hold" periods have also led to excellent returns.
  • While this hold cycle continues, Growth funds/ETFs are likely to excel the overall market.
  • But even better than Growth, small cap stock funds/ETFs have outperformed during these on-hold periods.
  • When the Fed does raise rates, Financial and Real Estate funds, along with Growth funds, will be your best bet.

The Fed Keeps Interest Rates Steady At 2 Percent

Chris Hondros/Getty Images News

The Fed has recently signaled that they will hold off on raising interest rates until at least mid-2022. They are sticking to the view that surging inflation is only temporary and they don't want raise rates while the job market has yet to return to its pre-pandemic level.

If they are true to their word, this means that investors probably shouldn't be overly concerned about rates until then. Why? Because, in prior time periods when Fed fund rates were on hold, neither rising or falling, the overall stock market has done extremely well. But what about when the Fed does start to raise rates? While that might appear to be a gloomy scenario for stock fund/ETF investments, it is much less so than many investors might think.

As my research showed in my last article here on Seeking Alpha, during periods of stable interest rates, such as right now, stock market investors have enjoyed the best time for high returns, based on past history over the last nearly 25 years. Perhaps surprisingly, returns under stable Fed policy were much better than when rates were falling. And even when these Fed-controlled rates were rising, the overall stock market has still fared pretty well, although not nearly as well, as when these short-term rates were on hold. Thus, my research suggests, we are currently in what might be termed a "golden period" for indexes such as the S&P 500 or funds invested in the total stock market.

Since mid-March 2020 when the Fed last dropped interest rates, they have kept rates on hold over these last 20 months. During this period, stocks have soared, which many may have attributed to a bounce back from the bear market brought on by the Covid-19 pandemic. But since their previous pre-pandemic highs in mid-February 2020, the overall stock market has not only recovered all its losses rather quickly (by Aug. 2020), but gone on to gain approximately an additional 45%.

This extreme degree of exuberance for stocks might be hard to understand although many explanations have been put forth. But one fact seems clear: With bonds, the chief competitor of stocks for investment money, showing little potential for returns with interest rates so low, many investors saw stocks as the only way to possibly generate a decent return. And since investors anticipated that rates would not be going up for well into the future, a belief continually encouraged by the Fed itself, they continued to bid up the prices of stocks and, right up to the present, still do.

The high returns, associated with stable interest rates we've seen since March 2020, are consistent with previous Fed cycles when short-term interest rates were being held constant by the Fed. However, the now 49.4% annualized return (through 11-17) for the most popular mutual fund and ETF, the Vanguard Total Stock Market Index (VTSMX, VTSAX, and VTI) tops the average annualized returns during the three other periods of stable rates; these returns averaged 19.4%.

But certain other types of funds may not have performed in line with the overall market in response to Fed actions. Therefore, in this article, I will look at the returns of several different categories of funds, such as Growth or small cap funds and a few sector funds, to see which ones shine vs. the overall market, as measured by VTSMX, when rates are stable. Such research can help answer whether one can find particular types of funds/ETFs that did even better than the overall market during periods when the Fed was also on hold. I will also look at returns for these funds when rates are rising or falling.

The funds I selected were popular funds that all have been in existence for at least 25 years. I examined their returns during the same Fed cycle periods of stable, rising, and falling rates as I identified in my prior article and are also shown under the tables below.

When Rates Were Stable

The following table shows returns and outperformances for four funds that I included that did better than the Vanguard Total Stock Market Index Investor Fund's (VTSMX) 26.94% during periods of stable rates. (All returns shown throughout this article are annualized.)

(Readers should note that certain Vanguard index funds such as VTSMX have different classes available for the same fund, only with slight differences in structure, such as expense ratio, minimum to open, etc. The reason I used the Vanguard Investor class in this research as opposed to either the fund's ETF class (VTI) or Admiral class (VTSAX) is that only the Investor class was in existence as far back as 1997, or nearly 25 years ago. Once these two latter classes came into existence, the returns shown in the following tables for Vanguard index funds would be nearly exactly the same as those for the Investor class, only perhaps ever so slightly higher.)

Fund Performance During Four Periods of Stable Rates

Fund

Average Total Return During Four Periods (see periods below)

Amount of Outperformance of VTSMX

Vanguard Small Cap Idx Inv (NAESX)

32.07

5.13

Vanguard Growth Index Inv (VIGRX)

29.79

2.85

Fidelity® Low-Priced Stock (FLPSX)

29.55

2.61

Fidelity® Contrafund® (FCNTX)

29.51

2.57

The four periods included:

June 25 2003 - June 29 2004

June 29 2006 - Sept 17 2007

Dec. 16 2008 - Dec. 15 2015

Mar. 15 2020 - Nov. 17 2021

When Rates Were Rising

Now let's look at which investments did significantly better than VTSMX's 10.89 when rates were rising.

Fund Performance During Four Periods of Rising Rates

Fund

Average Total Return During Four Periods (see periods below)

Amount of Outperformance of VTSMX

T. Rowe Price Financial Services (PRISX)

15.18

4.29

Fidelity® Contrafund

13.89

3.00

Vanguard Real Estate Index Inv (VGSIX)

11.97

1.08

Vanguard Growth Index Inv

11.58

0.69

The four periods included:

March 24 1997 - Sept. 28 1998

June 29 1999 - Jan 2 2001

June 29 2004 - June 29 2006

Dec. 15 2015 - July 30 2019

When Rates Were Falling

Did any of the funds included do better than VTSMX when rates were falling? Here the winners were FCNTX and VIGRX, outperforming VTSMX by 4.74 and 4.72% respectively. In fact, these two Growth funds outperformed regardless of which cycle the Fed was in.

Recommendations

Based on the above results, small and mid-cap stocks, as represented by NAESX and FLPSX, appear to be one's best choices for outperformance while interest rates remain stable, along with Growth funds. However, when rates start rising, the Financial sector, as represented by a fund such as PRISX, and the Real Estate sector, as represented by a fund such as VGSIX seem most likely to outperform along with Growth funds. The two Growth funds, VIGRX and FCNTX, having outperformed the overall market regardless of Fed cycles, would be one's best long-term bets of the funds I included.

It is interesting to note that the large cap Value fund, Vanguard Value Index Investor (VIVAX), that was also included among the selected funds I examined, did not outperform during any of the three Fed cycles over the last nearly 25 years. However, VGSIX, PRISX, and FLPSX are Value funds with a preponderance of mid and small cap stocks.

This article was written by

Tom Madell profile picture
1.53K Followers
Tom Madell, Ph.D., is the publisher of Mutual Fund/ETF Research Newsletter, a free newsletter which began publication in 1999 with thousands of readers. It has become one of the most popular mutual fund/ETF newsletters on the internet, as shown here. His site has been named as one of the "Top 12 Investment Newsletters Focusing on Mutual Funds" at mutualfunds.com , an important fund information provider, under "Fund Newsletter". Also, recently his Newsletter was recognized as one of 5 expert mutual fund resources worth following offering free, and, in its case, particularly "unbiased, useful, and original advice" at http://funds-newsletter.com/fundreference-art.htm .He is also a researcher/writer/investor whose articles have appeared on hundreds of websites, including the Wall Street Journal, USA Today, Morningstar and in the international media.His articles have been among the most popular among those posted on the Morningstar.com website by non-Morningstar employed contributors.His recommendations have an outstanding, long-standing record of success . His complete list of former articles can be accessed at http://funds-newsletter.com

Disclosure: I/we have a beneficial long position in the shares of VTSAX, NAESX VIGAX VGSIX VTV either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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