Stock returns during rate hike cycles are almost always positiveĪlthough drawdowns are bad, investors should care more about returns. The other interesting fact about rates and recessions is that the Fed is usually quick to act to support the economy and reduce the severity of the recession and that historically always means rate cuts. This is why some economists are already worrying whether the Fed can engineer a “soft landing” for the economy, which is where rate hikes slow the economy and inflation but don’t cause a recession.Ĭomplicating the Fed’s job is outside influences that may also slow the economy, including huge fiscal stimulus from 2021 that will fade from spending in 2022, combined with the impact of Covid that could either shock (in the case of more Covid) or relieve (if Covid retreats) employment and supply-chain constraints.
Sadly, a rate hike cycle often leads to the next recession (many, but not all, yellow zones in Chart 1 are followed by blue zones). So, it seems we should worry much more about a recession than rate hikes.Ĭhart 1: Stock market drawdowns against rate hike cycles and recessions Interestingly, looking at this from a valuations perspective, selloffs still happen even with super low interest rates, like we saw in the 1950s and again since 2004. In contrast, the selloffs in rate hike cycles, especially since 1975, are mostly much smaller corrections. If we add circles to show the maximum drawdowns in rate hike cycles (orange) and recessions (blue), we start to see that most of the largest selloffs are blue (recessions). We also show rolling one-year drawdowns in stocks (purple below the axis) and color periods of recessions in blue. We shade rate hike cycles yellow, including the Volcker-led rate cycle to crush runaway inflation in the early 1980s. The data in Chart 1 shows Fed rates going back almost 70 years (orange above the axis). Given the market selloff so far this year, with the S&P hitting a technical “correction” this week, down 10% from its recent highs, we look first at market drawdowns and the interest rate cycles. In fact, that’s exactly what happened in 2021.
If earnings rise, stock prices can stay flat or also rise even with climbing interest rates. However, there are two halves to the PE ratio: prices and earnings. That’s consistent with how valuations work – a larger discount factor makes future earnings worth less to an investor today. Historically, as rates rise, the price-earnings ratio (PE) of the market falls. We’ve previously discussed the headwinds that rate hikes cause for stocks. Rate hikes affect valuations and PE multiples And in recessions, the Fed is actually (usually) cutting rates. It turns out that recessions are what we need to worry about much more. And when the economy is strong, stock earnings are also usually growing. In short, it’s worth remembering that rates are generally rising because the economy is strong. The data isn’t as scary as you might expect. Today we look at whether rate hikes should really be feared, based on what has happened to stocks in past rate hike cycles. The market is preparing for the Fed to finally lift off from its “zero interest rate policy,” putting pressure on stocks so far this year.
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