Interest Rates and Markets

Monday, May 17, 2004 | 12:34 AM


As we've been discussing for some time now, objective data shows that -- all other things being equal (which of course they never are) -- stock markets can do okay in the face of rising interest rates; Indeed, if rates are rising as a response to impriving economic conditions, than markets will do well some 75% of the time (since 1971). And if you include previous tightening cycles, as Jim Stack of Investech research and Ned Davis of NDR have, the winning percentage post first rate hike is even stronger:

"All the hand-wringing aside, stocks fared better than many people might think in the eight periods of Fed rate increases since 1971 . . . history does indicate that the Fed can contain damage to the stock market by convincing investors that its rate increases will be gradual.

In six of the Fed's rate-tightening episodes, the Standard & Poor's 500-stock index was higher a month after the Fed stopped raising rates than it was before the central bank started tightening. The gains ranged from 4.3 percent, from May 1983 to August 1984, to 16.4 percent, from December 1986 to February 1989. The average gain was 9.4 percent. These are mediocre returns at best, but they are not the stuff of bear markets.

And any stock declines within these six episodes were relatively small, when calculated from the starting point. The biggest came during that 1986-89 period, which includes the 1987 crash: a fall of 9.8 percent in the S.& P. 500 from November 1986 to December 1987. The average was 4.7 percent.

The last Fed tightening began in June 1999 and ended in May 2000, as the technology bubble was bursting. The S.& P. 500 rose 13.2 percent over all for that period, although the bear market began in March 2000. But the rate increases contributed only a little to the damage that followed."

In most recent periods when the Federal Reserve has raised interest rates, the stock market has still managed to climb:

click for larger chart
Graphic courtesy NYT

"Of the two rate-tightening episodes that had overall stock-market declines, the first was during the 1973-75 recession. With inflation rising at double-digit annual rates, the S.& P. 500 plunged 26.6 percent into a bear market. In the other period, from December 1976 to March 1980, the Fed raised its benchmark rate to 20 percent. The S.& P. 500 was down 15.8 percent by March 1978, but recovered enough to reduce its overall decline for the period to 2.4 percent."

O.K., Investors, Who's Afraid of a Rate Increase?
Jonathan Fuerbringer
May 16, 2004


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