Much has been written about when the Federal Reserve Open Market Committee will raise interest rates. At its July 28 and 29 meeting, or later?
Many want to know, What will a rate increase mean for stocks? If a rate increase is on the horizon, what should an investor do today?
How will stocks react?
“Trying to predict the outcome of a big Fed decision is a fool’s errand,” says an article on cbsnews.com.
Yet, many try to predict what stocks will do. The overwhelming belief of those who spend time pondering the issue is that a Fed rate increase would be bad for stocks. Maybe.
- In October 1979, the Fed announced an unexpected rate increase. The S&P 500 fell nearly 6% the very next week. Not a good week at all.
- In October 1987, the markets did even worse. Five weeks after the Fed announced a rate increase, stock prices plunged. On one day, they dropped 22.6%. Ouch!
But is it always the case that a rise in rates lowers stock prices? No. Rate increases are not nearly as bad for stocks as many believe.
- Fed rate increases usually come when the economy is doing well. In fact, rate increases — a tightening of the money supply — often are a signal that the business climate has stabilized. This can be good for stocks because businesses can make capital investments, hire employees and develop their markets knowing there’s a measure of economic steadiness in place. It’s the exact opposite in a weak economy — when the Fed cuts rates to stimulate growth. But once growth becomes sustainable, the Fed gives the reins to business to stimulate further good results.
- Stock prices have risen in periods after a Fed rate increase. According to The Wall Street Journal, in three different six-month periods during which the Fed cut rates the S&P 500 produced a return of 16%. But even after those periods — when the Fed raised rates — the S&P 500 continued to grow. It averaged a 2% increase during the subsequent six-month periods. Not super great, but an increase nevertheless.
- The periods before a Fed rate cut tend to see stock weakness. The flip side of the coin is to look at the periods right before and right after the Fed has tried to stimulate the economy. Again, easing usually happens when things are going badly. The six months following easing tends to see average drops of more than 8% for the S&P 500, according to The Wall Street Journal. Six months before easing begins, stocks barely break even.
Remain calm and rational
Can we use this data to predict what markets will do when the Fed raises rates? Of course not. But, should we be like Chicken Little and worry that Doomsday is coming? Hardly.
So, what should you do?
- Have a conversation with your advisor.
- Make sure your portfolio is dialed in to match your objectives and risk tolerance level.
- Ignore the news hype over the Fed.
That’s a calm and rational response to the issue. Calmness and rational thought — two qualities that many investors overlook at their own peril.