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Rising Interest Rates & Long Term Stock Returns
Submitted by Lance Roberts via STA Wealth Management,
With the Federal Reserve now indicating that they are "really serious" about raising interest rates, there have come numerous articles and analysis discussing the impact on asset prices. To wit:
"'Stocks typically sell-off on the first of a series of rate hikes, but the magnitude and duration of the sell-off depend on conditions,' Bianco writes. 'During early cycle hikes the initial sell-off was generally small, quickly recovered and further S&P gains came in next three months and longer (like 2004, 1983, 1972). But many sell-offs on late cycle hikes became corrections or even bear markets.'
Unfortunately, it's only in hindsight do we know where we are in the cycle.
While David is correct in his analysis, in my view, it is too short of a window for investors. While the markets, due to momentum, may ignore the effect of "monetary tightening" in the short-term, what about longer-term?
That is the question I want to examine today. As shown in the table below, the bulk of losses in markets are tied to economic recessions. However, there are also other events such as the Crash of 1987, the Asian Contagion, Long-Term Capital Management, and others that led to sharp corrections in the market as well.
The next table shows the date of the first Fed rate hike, the corresponding level of GDP at the time of the first rate hike and the financial markets. It also counts the number of months until the next event which was either a recession, a market correction or both.
The point is that in the short-term the economy and the markets (due to the current momentum) can SEEM TO DEFY the laws of gravity as interest rates begin to rise. However, as rates continue to rise they ultimately acts as a "brake" on economic activity. Think about the all of the areas that are NEGATIVELY impacted by rising interest rates:
1) Rising interest rates raise the debt servicing requirements which reduces future productive investment.
2) Rising interest rates will immediately slow the housing market taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments. (Read "Economists Stunned By Housing Fade" for more discussion)
3) An increase in interest rates means higher borrowing costs which leads to lower profit margins for corporations. This will negatively impact corporate earnings and the financial markets.
4) One of the main arguments of stock bulls over the last 5-years has been the stocks are cheap based on low interest rates. When rates rise the market becomes overvalued very quickly.
5) The massive derivatives and credit markets will be negatively impacted. Much of the recovery to date has been based on suppressing interest rates to spur growth.
6) As rates increase so does the variable rate interest payments on credit cards. With the consumer being impacted by stagnant wages and increased taxes, higher credit payments will lead to a rapid contraction in income and rising defaults.
7) Rising defaults on debt service will negatively impact banks which are still not adequately capitalized and still burdened by large levels of bad debts.
8) Many corporate share buyback plans and dividend issuances have been done through the use of cheap debt, which has led to increases corporate balance sheet leverage. This will end.
9) Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs leads to lower capex.
10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.
I could go on, but you get the idea.
However, the mainstream media continues to run with the idea that you shouldn't fear the Fed beginning to increase interest rates. This is something that I addressed more deeply in "Don't Fear Rising Interest Rates? Really?"
"Do Rising Interest Rates Lead To Higher Stock Prices? This claim falls into the category of 'timing is everything.' The chart below has been circulated quite a bit to support the "don't fear rising interest rates" meme. I have annotated the chart to point out the missing pieces.
As I stated above, timing is everything. While rising interest rates may not "initially" drag on asset prices, it is a far different story to suggest that they won't. In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest rate hiking campaign that has not eventually led to a negative outcome.
What the majority of analysts fail to address is the "full-cycle" effect from rate hikes. While equities may initially provide a haven from rising interest rates during the first half of the rate cycle, they have been a destructive place to be during the last half.
While the mainstream analysis is not to fear rising interest rates in the short-run, as longer-term investors it is crucially important to the preservation of investment capital to understand the dynamics of increasing interest rates.
In summary, here are the things that you need to know:
1) There have been ZERO times that the Federal Reserve has entered into a rate hiking campaign that did not have a negative consequence.
2) The average period following an increase in the effective funds rate to either a stock market correction, economic recession or both has been 20.75 months. Therefore, if we assume an initial increase in the Fed funds rate in June of 2015, that would put the next negative event sometime in the first quarter of 2017.
3) However, the median number of months following the initial rate hike has been 17 months. This would advance the timeframe into mid-2016. Such a timeframe would coincide with both the Decennial and Presidential cycles as discussed previously.
4) Importantly, there have been only two times in recent history that the Federal Reserve has increased interest rates from such a low level of annualized economic growth. The most relevant period was in 1983 when the economy was recovering from two adjacent recessions. Due to such weak economic growth, the impact of rising interest rates tripped up the stock market just 17 months later.
5) Lastly, it is crucially important to recognize that the ENTIRETY of the "bullish" analysis is based on a sustained 34-year period of falling interest rates, inflation and annualized rates of economic growth. With all of these variables near historic lows, we can only really guess at how asset prices, and economic growth, will fair going forward.
What is clear from the analysis is that bad things have tended to follow the Federal Reserve's first interest rate increase. While the markets, and economy, may seem to perform okay during the initial phase of the rate hiking campaign, the eventual negative impact will push most individuals to "panic sell" near the next lows. Emotional mistakes are 50% of the cause as to why investors consistently underperform the markets over a 20-year cycle.
For now the bullish trend is still in place and should be "consciously" honored. However, while it may seem that nothing can stop the markets current rise, it is crucial to remember that it is "only like this, until it is like that." For those "asleep at the wheel," there will be a heavy price to pay when the taillights turn red.
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Raising rates might save the economy, but it will kill off the federal government. Sounds like a win to me.
You guys didn't hear, this time IS different. #raiseratesnow
Where in hell did Reggie's post go to???
Itll take some banks with it too!
Did not Zero Hedge go through a big post on Why Interest Rates Will Not Go Up ???
So why post this crap. Is this the classic Flip Flop ???
I have full faith in Calamity Janet (sarc)
here comes a 1 basis point rate hike...with 2 or 3 to follow
^^^this, criminals and sociopathes never indict themselves or give up power and control.
Oh.
Then sell gold...
The problem is that much of the DEBT is fraudulent to begin with. This is debt that was placed on the back of the majority to the benefit of a chosen few. Let me be clear, fuck em.
If all these "emergency measures" or the excuses that "we had to do this to save the economy" have worked, fine, raise rates!!!!!!
If this cannot be done then there will not be a progress from here unless the taxpayers get a serious refund. It's that or face retribution motherfucker.
I guess we should keep rates at zero then
I vote for negative rates and banks paying you to take out another business loan!!!
Go big or go home right?
/s
FED will use upcoming war or Euro problems as excuse for no rate hikes.
They will not raise rates. They cannot raise rates.
why does the fed have to raise interest rates?. or are they just following the bond market?
Eventually, to defend the dollar. When rates go negative enough, IDK exactly where, -1% or more, people will abandon them. Negative rates in other countries is temporarily helping the FED. Notice, gold and dollars rising simultaneously for the last few months.
The central banking cartel will never raise rates. They don't need to as long as the other cartel members keep theirs low as well. And when inflation starts kicking-in, they'll simply "adjust" the data to hide it.
SP500 chart looks to be right on pace.
Jon Gruber is correct. Americans are stoooooopid.
The private fund managers should have been all over the real estate industry back in 2001 when we were already in a bubble. They should have been pulling their funds and demanding bank manager firings. much is made of the feds leaning on the banks to make ill advised mortgage borrowers. Bank presidents listening to the threats from Eric Holder and Al Sharpton are one thing. Having fund managers tell them to not make bad loans or their funding source will go away is quite another.
The bubble grew and burst. The Fed bailed out the banks and feckless managers. And the fund managers had to invest to get their requisite 8% returns in what??? Surely not government bonds yielding 3%. This is going to be sooooooo painful.
Hey!!! I just turned 65. Start those checks coming baby. What??? You gave all my money to Jamie Dimon back in '09. Gee whiz. Sure wish I had paid attention and harried my congressman.
Of course I have been a pain in the a&^ to my congressman, but it didn't do any good.
Will we see septagenarians going after bankers in gated communities with nail guns? Pass the popcorn.
Bullish is a way of life!!!!!!
It seems in the MSM there is a consensus that QE has "worked".
Federal government statistics (fraudulence notwithstanding) endorse this being the case.
Hence the scene is set for tentative rate rises.
All sane humans know this will tank the economy.
QE will be reinitiated once this occurs: "It worked last time!"
This cycle will continue until the utter lack of efficacy of QE, and its frankly pernicious effects, are obvious to all and sundry.
At the heart of my thesis is: who is actually benefitting from QE?
many, myself include, have been cashing out and adding to the store of dry powder for just such a scenario.
Same as it ever was...
the red picture of rising interest rates at the intro.
so suggestive.
LOL "raising rates" LOL. Get ready for QE4, not that QE 3 ever "ended", the Fed's balance sheet hit another alltime high in the December quarter. Huh? Yeah they said they would not shrink it until *at least* the end of the decade, everything that matures gets rolled into new monetization, $16B last month. That's like a new asset manager with AUM of $16B opening their doors every month and the only thing they're allowed to do is BUY.
Race to ZIRP on the 30-year with the Swiss leading the pack at 0.37%.
I don't think a rate hike will ever come, and when I say that I mean a real rate hike, not some 1 or 2 bp 'hike' or similar. If the Fed does hike it will be something symbolic so they can say they did it but we will never see rates at their historic levels ever again, that is until the Fed has fully lost control, but that could be some years away too. We'll blunder down this Japanified route for a while before they're forced to do something.The rate hike will just continue to get pushed out into the future at some undefined time.
As for the Fed balance sheet, good luck ever normalizing that mess.
The above analysis is pertinent but I believe that any significant hike would bring about a calamity much more quickly than is being proposed in the above article, at least the initial calamity. There might be subsequent downturns in stock prices too which occur later but the initial jolt will not take months to appear. The historical data regarding that is important but the analysis fails to take into account where we are technologically and how that is vastly different from market downturns in the past. I think people are already hudled at the exits wanting to be the first out the door when the shock occurs.
We will never see fed funds above 1% again.
I will ask this question again, does anyone see a true catalyst for rates to increase in the next 10 years?
Before you answer, keep in mind that rates have been perpetually low since 9/11.
The dollar’s ascent is already eating into American corporate profits.
Somebody please challenge this thesis.
The catalyst will be mounting positive assessments of the economy (fraudulent of course).
Does anybody proof read anything anymore? First graph/table says S&P hit 1950 in 2001 and I'm pretty sure the S&P never hit 665 in 1969. Am I missing something?
Raise the rates... I want the stock market to correct.
Rate hikes???
Get a clue here folks, if you hike rates, money flows into
your country, which begets a need to invest that money.
In WHAT you may ask, other than USTs???
Therein lies the rub, all that money flowing into the US$ is
getting trapped. All other CBs are actively lowering rates or
indeed going NIRP ( as per Switzerland ), because if all that
money flowed into their countries ( as with the USA ) there
would be no effective investment vehicle other than gov't
bonds.
And THAT is a death trap for capital and the currency in question!!!
" All other CBs are actively lowering rates or indeed going NIRP"
That's because ZIRP has run out the clock. Because of ZIRP, Sovereign and Corporate debt has ballooned. They need NIRP to finance the extra debt load. Although NIRP arrives first to the nations that are in the best financial state, as savers move capital to places that are less risky. The Bigger players (France, US, China) will land in NIRP land eventually.
"There have been ZERO times that the Federal Reserve has entered into a rate hiking campaign that did not have a negative consequence"
There has never been a time when the Fed Lowered rates that it did not have a negative consequence.
<i>1) There have been ZERO times that the Federal Reserve has entered into a rate hiking campaign that did not have a negative consequence.</i>
In the short term yes, in the long term, it is absolutely necessary to clear out the defective managers who bungled the economy. Contrary to the doom and gloom of this article, I look forward to the buying opportunity it poses. For you technical folks, short, short, short!
BTW- This would be a good opportunity for the Fed to clean up the Treasury balance sheets by letting all the fools buy bonds at the current interest rate level, then BAMM, raise interest rates to 5% thus shrinking the national debt to 20% of it's current level. If you know anything about bonds, the principle must drop to match the par level of the higher interest paid on new bonds. Only a fool owns bonds at these rates.
Yum, yum, it smells like chum! I smell a feeding frenzy...
Contrary to the idiots handling the economy, the business cycle has not been canceled, it has been waiting with pent up fury to correct the stupidity of those who foolishly think there are no consequences and bail outs forever.
I am prepared for a "symbolic" rate hike. Like above, a 1bp hike.
Here is a website that confirms deflation is inevitable using 52 years of Fed data aka FRED data.
http://michaelekelley.com/2015/02/11/fed-inflation-target-is-abnormal/
Thanks