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Why Rate Hikes Don’t Imply the End of Long-Term Performance

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This possibility raises the question: What difference, if any, will a delayed hike make for stocks?

As I discussed earlier this year, in the Market Perspectives paper No Exit: Can the Fed Normalize Rates-And How Will It Impact Stocks?, an initial rate hike has historically been a temporary headwind for stocks; it has rarely been a harbinger of a bear market.

Whether or not the Fed decides to raise rates in December, January, or April is unlikely to be the primary determinant of how the broader US market performs. However, there are certain segments of the market that are more sensitive to changes in monetary policy and may benefit from any delay by the Fed.

Rate Hikes Do Not Imply End of Long Term Performance

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Market Realist – Rate hikes don’t mean the end of long-term performance.

A clear pattern emerges in the performances of the S&P 500 index (IVV)(RSP) during the last few rate cycles. The three-month returns after the start of tightening have been negative and volatile (VXX)(VIXY), a knee-jerk reaction to the start of a tightening cycle. However, in the six or 12 months after the start of a period of steady tightening, markets rallied and, on average, saw positive returns.

The average three-month, six-month, and 12-month returns after tightening have been -4.3%, 3.6%, and 4.1%, respectively, since 1994.

This time around, though, the tightening process will be much gentler compared to the one in the Greenspan era in 2004. So its impact on equities (IWB)(VTI) is likely to be muted. Having said that, valuations are pretty high at the moment. The S&P 500 (VOO) is trading in the region of 18x earnings. Rich valuation coupled with mildly higher rates represent a headwind for stocks. Also, diverging central bank policies could cause an even stronger dollar (UUP), further eroding the revenues of multi-national companies.

We’ll focus on the segments that stand to benefit if the Fed delays the rate hike.

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