What is the Fed doing?
Don’t fight the Fed. An adage that is a good rule of thumb for equity investors. The Federal Reserve is on a mission to squash inflation. It will do that by hiking interest rates and reducing liquidity in the economy or basically unwinding all that it has done over the past decade.
For over a decade, the Fed held interest rates low and flooded the economy with liquidity. This sent equity prices higher producing handsome returns for years. Now the game is changing, as the Fed increases interest rates, equity valuations are adjusted sending stock prices lower. Historically, equity prices are soft until the Fed is close to the end of its hiking cycle. According to the Fed’s forecast, Fed Funds will peak at 3.75% sometime next year. Perhaps a long way to go.
What’s the impact?
Higher interest rates can impact the stock market and sectors differently depending on why rates are on the rise. In the past 30 years there have been four Fed rate- hike cycles. Historically, the technology sector is among the best performers. Why? Because the economy was expanding as the Fed started the hiking cycle, and the Fed was just tapping the brakes to slow growth. Yet in the past four cycles, sector leadership has varied, but technology, real estate, energy, and health care have all performed well. This cycle has its own set of nuances, inflation is on fire while economic activity is cooling. Our conclusion is that there is not one sector that definitively outperforms in every Fed hiking cycle.
Investors should keep in mind that many times there is more than just one factor, i.e., interest rates, driving returns.
Today’s higher rates is a response to spiking inflation. Commodity related sectors, such as energy and materials, perform well when inflation is driving interest rates up. Additionally, companies in the finance sector may perform well when interest rates are on the rise, but banks also require a steep yield curve to perform well.
What should investors do?
The answer is always the same, have a financial plan, understand your goals and objectives, then build a diversified portfolio with the proper risk/return characteristics.
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This article is for informational purposes only and is not intended to be investment advice. The projections in this article are based on information as of a specific time and are subject to change. Please contact your investment advisor with any questions.