|
THE HISTORICAL RELATIONSHIP
BETWEEN RISING INTEREST
RATES AND STOCK PRICES
One of the major questions
facing investors today is
how the US equity markets
will react when the Federal
Reserve begins to tighten
monetary policy and raise
interest rates in order to
reduce the amount of
stimulus in the economy.
We thought this to be a
particularly timely review
given that at the end of
February the Federal Reserve
raised the Discount Rate
from 50 to 75 basis points.
The initial reaction in the
stock markets when the rate
was increased was a sharp
sell-off. Shortly thereafter
Chairman Bernake, when
providing testimony to the
US House Financial Services
Committee, explained that
the rate increase was not
part of a change to overall
monetary policy and that
given current conditions
interest rates would
probably remain low for some
time. While this was
received positively by
investors and low interest
rates are certainly helpful
to stimulate economies
looking to recover after
periods of recession, the
flip side is that the US
economy is still a bit weak
and battling high
unemployment and a weak
housing sector.
While Coral Gables Trust’s
Investment Committee has
shared its views on the
overall economy (we are in
the initial stages of
Recovery) the equity markets
(the S&P500 offers
interesting upside potential
given earnings estimates and
valuation) and the fixed
income markets (invest in
shorter maturities and lower
duration instruments given
potential for rising
interest rates), we thought
it particularly helpful at a
time like this to review
what has happened in the
past to the S&P 500 when
interest rates began to rise
after periods of lower
rates.
Over the past 20 years there
were three occasions (1994,
1999, and 2004) when the
Federal Reserve increased
the Fed Funds rate after a
period of lowering the rate,
as shown below.
The stock market’s initial
reaction in all three
instances was an immediate
sell-off with the S&P 500
Index ending down on average
by 3.2% after a one-month
period. During the second
month the market was
slightly negative on two
occasions (1999 and 2004)
but declined particularly
further in 1994. In that
year it took seven months
for the S&P 500 to return to
the level prior to the
interest rate increases,
while in 1999 and 2004 it
took a relatively short
period of approximately five
months.
The take-away from this for investors is that during periods of rising interest rates after periods of lower rates, stocks moved higher despite further rate increases. This reminds us that during periods of economic contraction, interest rates are lowered as part of an overall strategy to provide stimulus to help economies move out of recession and into recovery. During the periods of recovery and later expansion, the Federal Reserve tends to then adjust interest rates upward as part of its overall strategy to help manage the expansion so economies grow in contained and orderly manners. Economic growth tends to correlate well with stock market advances and therefore history has shown us that as interest rates rise after recessions, after a very brief period, stock prices tend to rise as well.
On behalf of Coral Gables Trust’s Investment Committee,
Sincerely,
Joseph Nader
Chief Investment Officer
|
