The Federal Reserve is widely expected to approve its first interest rate increase this week in what may be a long campaign of rate hikes designed to tamp down rampaging inflation.
The Fed is expected by Wall Street to raise the federal funds rate by a quarter point on Wednesday, marking the first rate increase in four years and the end of the extraordinary measures the Fed has taken to keep interest rates near zero in order to resuscitate the economy during the pandemic.
Historically, stock prices increase during the months following rate hikes, Morningstar analysts Sandy Ward and Lauren Solberg said in their new blog today. Other analysts agree.
“In the short term, it’s been pretty well choreographed that it will be a 25 basis point rate hike, so we don’t expect the stock market to overreact,” Paul Hickey, co-founder and president of Bespoke Investment Group, a market research and wealth management firm based in Harrison, N.Y., told Financial Advisor.
“[Fed] Chair [Jerome] Powell pretty much stated as much in testimony in front of Congress last week. At this point, because it’s pretty well anticipated. … We don’t expect the stock market to overreact. We are more concerned with fallout from the Russia-Ukraine war,” Hickey added.
For instance, the stock market went on to soar to a three-month return of 12.51% after the Fed’s rate initial rate hike of a quarter point in March 1997. Six-month returns hit 20.86% and 12-month returns skyrocketed to 41.04% by March 1998, according to Morningstar.
In June 2004, stocks dipped 1.35% the first three months after the Fed’s initial 25 basis point rate hike, but rallied to 8.8% at the six-month mark and 8.82% after a year, Morningstar found.
Much of the stock market jitters around Fed hikes already played out in January, Morningstar’s chief U.S. market strategist, David Sekera, said in the Morningstar blog. As rate hike expectations grew, stocks, especially growth stocks with higher valuations, were the hardest hit, he said.
Because investors are counting on the future earnings of growth stocks, they tend to get hit hardest during inflationary times, Sekera added.
“As investors lower their growth expectations and discount those future earnings at a higher rate, the present value of the stocks falls further and faster than the broader market,” he said.