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Fear the Fed?

By Matthew J. Carvalho, Director of Investment Research, Loring Ward

“The Fed’s rate hike could cause chaos in markets — and investors may not be ready.” While this could easily have been a headline from this year following Federal Reserve (Fed) rate hikes in March and June, this particular headline from Reuters came out in December 2015, just before the first rate hike in the years following the financial crisis.

Nearly two years later you continue to hear noise about the Fed raising their target rate, which had been close to zero since December 2008. Will consumers and companies have trouble adjusting to interest rates above the dreary levels of recent years? As the Fed continues to raise rates, does it mean we should flee stocks?

We looked at what has happened historically after the Fed raised rates. As the chart shows, rates in general have fallen quite precipitously over the last 30 years, and while we’ve seen a few upticks since December 2015, we are still at low levels. At the same time, the stock market has continued to head higher. Does this mean that if rates start to rise, stocks will head in the opposite direction? The data would say no.

Source: Federal Reserve Bank of St Louis and Morningstar Direct. Fed Funds Target Rate and S&P 500 Price Return levels from 9/27/1982 to 7/31/2017. Indexes are unmanaged baskets of securities that are not available for direct investment by investors. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.

The Fed made 73 rate hikes between September 1982 and November 2015, and the average return on the S&P 500 during the 12 months after a rate hike was 11.3%. Three years after a rate hike, the index price rose by 10.4% annualized, and five years later rose 10.9%. More recently the S&P 500 is up 16% in price from the initial hike in December 2015 through July 2017.

This makes sense when you think about what often drives the Fed to increase rates — namely a healthy and expanding economy, which may lead to inflationary pressures. However, we would be wise to avoid reading too much into any one factor. After all, stock prices represent a collective view about the future, taking into consideration dozens of factors including earnings, the economy, inflation, politics, tax rates, demographics, currency exchange rates, consumer sentiment, etc. Focusing on just one factor, like the Fed decision, is likely to do more harm than good. And the collective view isn’t always right.

Instead, we believe that the best course of action is to review your portfolio with your financial advisor to see if your investment allocation still aligns with your financial plan. Fed statements and moves are sure to command many headlines for the foreseeable future, but chances are that when we look back a few years from now, we’ll have forgotten what all the noise was about.