At the time of this writing, the Standard and Poor’s 500 Index (S&P 500) had seen recent weakness stemming from investors’ worries of future actions by the Federal Reserve raising of rates. The S&P 500 entered “correction” territory in January. A “correction” is typically denoted by a 10% pull back from market highs. The S&P 500 index tracks the largest 500 company stocks in the U.S. stock market and is widely tracked by market professionals as a general gauge of stock market performance. Given this recent market weakness, we thought it would be interesting to revisit happened to the markets during previous Federal Reserve rate hike cycles.
Using data obtained from www.federalreserve.gov, we observe the historical target federal funds rate as established by the Federal Open Market Committee (FOMC) going back to 1990. Since it is widely anticipated that the FOMC will be raising rates in the future, we concentrated our attention on the historical periods when the target was increased. We defined a cycle by taking data from the quarter before the first increase to the quarter end after the last action. Please note there were only four data sets available and duration over which the FOMC acted ranged from approximately 5 calendar quarters to 13 calendar quarters.
Using returns of the S&P 500, we charted how $100 invested in this index would have behaved over each period when the target rate was rising. As you can see in the chart on the following page, despite the FOMC raising interest rates, the S&P 500 had a positive performance over that time.
For curiosity’s sake, we performed the same exercise using the Bloomberg Barclays U.S. Aggregate Index which serves as a proxy for the overall US bond market. In one period, bond returns dipped negative as interest rates rose. This is expected as bond values move inversely to interest rate. Surprisingly, by the end of the period of increasing interest rates, fixed income returns in each of these data sets was positive despite the increase in rates.
Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
The above illustrations should certainly be taken with a “grain of salt” since the sample size is incredibly small, economic conditions were different, interest rate environment was dissimilar, and there are many other variables to name that can change future outcomes. The chart also does not show how the market behaved in periods following the rate hike period. At the same time, we should acknowledge that headlines ushering in fear because due to FOMCs actions, may not tell the whole story.
The bottom line is we don’t believe anyone can accurately predict the financial markets and continue to believe that long-term investors should be compensated for taking financial risk.