What Happens When the Fed Raises Rates

August 31, 2015 | by Justin Capetola

Rising Interest rates

To move the U.S. economy out of the carnage left from the Great Recession, the Federal Reserve Bank adopted a near zero interest rate policy almost 8 years ago. This policy, along with FOMC operations such as QE1, QE2, etc. was unprecedented and has had an enormous impact on the stock market. The FEDs balance sheet has grown from $1T to $4.5T while the stock market has tripled in price from the March 2009 low. Corporate earnings have grown… With the U.S. economy on more stable footing, attention is now being focused on when the FED will hike rates and how much. Aside from the issues with Greece, much of the volatility we have seen in 2015 is a result of speculation on FED actions. Raising the interest rate should signal that the economy is in fact stronger than it has been. But, we have never been in a near zero interest rate environment for so long and we have never been through so many rounds of easing. The volatility about this speculation centers on this question – What will happen to the stock market after the FED ends the near zero interest rate policy?

Nuveen Asset Management’s Bob Doll wrote an article in Barron’s that summarizes the performance of stocks before and after rates rise. When rates rise, the end to the rising stock market is not necessarily over.

Equities have survived rate hikes

(click on image to enlarge)

The key difference between these past rate hikes and this one is that the starting point is much lower – zero! With the FED assistance coming to an end, the stock market (and economy) will have to stand on its feet, unaided. Earnings will again take center stage as the primary driver (or lack thereof) for years to come. If the historical trend outlined above continues, the stock market should continue to outperform other asset classes and especially cash and fixed income. This time will occur with an increase in volatility. Our hedged equity approach seems appropriate given what we think lies ahead. Using structured notes and structured CDs that provide some downside protection and options to partially hedge should provide investors a means to participate in the growth in the stock market for years to come, while reducing some of the associated volatility.


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