Why have markets been selling off?
Folks were hoping that tamer inflation would cause the Federal Reserve to pull back on its interest rate hikes. Unfortunately, the hot inflation data from last month resulted in the Fed raising rates 0.75% again today, signaling its willingness to continue aggressive rate hikes in the months to come, spooking investors who expected a pivot away from higher rates.
When the Fed sets higher interest rates, it increases the cost of credit across the entire economy, making mortgages, car loans, credit cards, business financing, etc. more expensive. Investors worry that those higher rates will slow the economy (and maybe tip it into recession) and ding company performance. Higher interest rates could also make investors less willing to accept steep valuations amid risks to future earnings growth.
What could be the longer-term impact of rate hikes?
Whenever we want to understand what could happen, it's useful to go back in time and take a look at what’s happened before. While the past can't predict the future, it's often a useful guide. An analysis of 12 previous rate hike cycles shows that, overall, equity markets handled tightening reasonably well. Across these cycles, the S&P 500 averaged a total return (including interest, dividends, etc.) of 9.4%.1
So, what can history teach us?
Stocks tended to take rate hikes in stride over time. However, those historical gains didn’t come in a straight line. They included dips, shocks, selloffs, and bear markets. They even included a few recessions. Folks who bailed on the ride down probably missed a lot of the ride back up. Predictions are a murky business. While what happened in the past is useful to a point, it's not a map of the future.
What’s the bottom line?
I think more volatility is definitely in the cards in the days and weeks ahead - nothing new here. As investors digest today's Fed decision, economic data, and upcoming Q3 corporate earnings, we’re going to likely see more erratic movements, both positive and negative. What's happening now is the Fed is trying to reassert its inflation narrative and quell the optimism that fueled the rally at the end of the Summer. Because the markets are forward looking, they are trying to assess when the Fed hikes will cease and eventually show signs of potential rate cuts. Until this uncertainty is a little more known, brace yourself as this volatility will persist.
As always, if you'd like to discuss what we are doing specifically for your portfolios, please let us know.
Matt Mellier, CFP® & Team HWC
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