For weeks, the stock market has been concerned about the potential for the Federal Reserve to raise interest rates for the first time since December 2015. History shows that rate hikes, on their own, are not the consistent drag investors often perceive them to be.

Since World War II, the Federal Reserve has embarked on a rate increase cycle 17 times. Six months following the initial rate hike, the S&P 500 on average was up only 1.3%. However, significant losses in 1946, 1973, and 1987 drove this average down. Minus these three years, the average rises to 4.91%. Post-war inflation, dislocations from an oil embargo and what some people think was simply a Fed error led to the losses in those years.

A similar situation was present 18 months after an initial rate boost. Backing out the post-war losses in 1946, lingering problems from the Vietnam War in 1968 and the 1973 oil situation more than doubles the average gain months after the first rate increase.

There is no doubt, however, that the equity market prefers a falling rate environment. During the 17 rate cutting cycles since 1945, 18 months after the Fed began cutting interest rates, the S&P 500 gain is 3.5 times greater than what was achieved during the 17 rate hike cycles.

As is true in all data that attempts to assign a likelihood of a market reaction, regardless of how compelling the data might appear to be, it is unwise to assume any signal or pattern always is correct.

Also, rate increases and decreases are cyclical. Investors in the early 1980s struggled through the sharpest interest rate increases since the Civil War that saw the Fed fund effective rate reach 22.36% by July 1981. They also saw this same rate for government paper 13 months later fall more than 50% while the S&P 500 was up 33% through this drastic rate hike and cut cycle.

 

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