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Which investments spike when interest rates hike?
RCM Alternatives recently distributed an impressive infographic (see below) on the effect of interest rate increase cycles on stocks, bonds, and alternative investments.
As a prepared financial advisor, RIA, or financial planner, you probably want to know what might happen when rates finally do go up – so you can better explain all to your clients and prospects. And of course to be better prepared for allocation and investment decisions.
Yes, interest rates obviously impact investment trajectories. The Fed Funds target rate also impacts bond prices, margin rates, savings rates, house loans, and auto loans.
When Will Interest Rates Go Up?
Who knows? Maybe Janet Yellen knows, but should we care?
One thing we may say with some comfort – interest rates can’t go much lower. (Or can they?)
As of June 30, 2016, the fed fund target rate was between 0.025% and 0.50%.
The Fed moved the target rate to zero more than seven years ago, on December 16, 2008, where it remained unchanged until December 2, 2015. Prior to last December, the last rate increase was in 2001, when the Fed raised the target rate to 5.25%. Since then, it’s been mostly a slow decline, or at zero.
“The fed target rate is the interest rate charged by one depository institution on an overnight sale of balances at the Federal Reserve to another depository institution, as determined by the Federal Open Market Committee (FOMC) of the Federal Reserve.” (Source: Investopedia.)
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What the Hike?
Since 1983, we have witnessed six cycles of rate hikes. Three were in the 1980s, two in the 1990s, and one in the oughts.
The average rate increase per cycle was 2.81%.
The average length of an interest rate up cycle was 14 months.
Does this mean that the next set of increases, whenever they occur, will be similar in scope and length? Of course not, but you have to start somewhere, and history may be a pretty good guide, so why not start with history?
The Impact on Asset Classes
So how do different asset classes react to rate hikes?
Let’s use one time period, namely, one year after the hike cycle. (See infographic for more). After 12 months of increased interest rates, stocks, as measured by the S&P 500 Index, lost 10.00% of their value, and bonds lost 5.00%, as proxied by the U.S. Aggregate Bond Index.
Is there an alternative? Yes, and it’s alternative investments – hedge funds, managed futures, and CTAs, for example. One year after the same interest rate hike cycles, on average, managed futures did 17% better than stocks, and hedge funds did 2% better. (Managed futures results were represented by the Barclay CTA Index, and hedge funds by the Dow Jones Credit Suisse hedge Fund Index.) Past performance you fill in the blanks, I mean, cannot guarantee future similar results.
The Height of Folly?
As RCM notes, the Fed has had nine chairmen since its’ founding in 1913. Of the last four, each chair has been shorter than the previous prime interest make maker.
Paul Volcker, who was Chairman of the Federal Reserve from 1979 to 1987, was 6’7”; Alan Greenspan (1987-2006) is 5’11”; Ben Bernanke (2006-2014) is 5'8"; and current Chairperson Janet Yellen is 5’3."