NEW YORK — It’s no surprise that the prospect of a Federal Reserve rate hike worries stock investors.
The Fed’s unprecedented economic stimulus has in large part driven a surge in stock prices since 2009. The central bank has bought trillions of dollars of bonds and kept short-term interest rates close to zero. That’s allowed businesses and consumers to refinance their debt at lower rates, freeing up cash to spend. But if history is a guide, investors have nothing to fear.
In the nine instances since 1955 that the Fed has started raising rates after a recession, the Standard & Poor’s 500 index has risen by an average of 58 percent between the first hike and the peak of the market, according to LPL Financial, an independent broker-dealer based in Boston.
The Fed is set to end its bond purchases in October, and most economists expect the first short-term rate hike by mid-2015.
These early increases, analysts say, are unlikely to derail the current bull market for stocks, because the Fed would be raising rates in response to a growing economy. Manufacturing expanded in August at the strongest pace in more than three years. Hiring is also picking up, along with consumer confidence.
“Rising interest rates are usually a symptom of the success of the economy, and companies are benefiting from it,” says Seth Masters, chief investment officer for Bernstein Global Wealth Management. “Generally, that’s pretty good if you’re a stock investor.”
Research from Burt White and Jason Nicastro at LPL shows that after an initial bout of volatility, stocks typically rise along with rates.
The last time the Fed raised rates was 2004. The market flinched at first, with the S&P 500 dropping 3.4 percent in July after rates rose from 1 percent to 1.25 percent. The index then climbed for another three years, gaining 37 percent between the first rate increase and the market’s peak in October 2007.
Stocks rise when the Fed lifts rates enough to contain inflation, but not by so much that the hikes suffocate borrowing and lending.
A healthier economy also means stronger corporate earnings, which drive stock prices, says Jim McDonald, chief investment strategist at Northern Trust Asset Management.
Of course, the Fed won’t always read the economy right, and that’s what makes stock investors nervous.
Four of the five previous bull markets since 1970 ended as investors got spooked by a recession, or the anticipation of one, and sold stocks. And what causes recessions? In three of the past five, it was the Fed hiking interest rates to slow inflation.
Typically, though, the problems for the economy and stock market don’t come until after the Fed has hiked rates a number of times, not early in the process.
