Skip to main content

You are here

Blog Listing Page

A stylish look at the fed

By: Tom Goodwin, Senior Research Director

It seems one cannot open a financial newspaper or tune into an online interview without hearing speculation about when the Federal Reserve Bank (the “Fed”) will raise interest rates, how far, and how fast. This has been going on for years now, with pundits poring over the arcane statements of successive Fed chairpersons. It would be comical except that the consequences for investors if the Fed should raise interest rates are highly uncertain and potentially large.  In hopes of shedding light on the impact of rising rates, I took a look at the historical record to see how equity style indexes have responded to periods of rate hikes in the past.

I decided to focus on the four periods of tightening monetary policy in the last 30 years, beginning July 1986, February 1994, June 1999 and June 2004, and then examine the responses of Russell US large cap, small cap, value and growth indexes to these periods of rising rates.

 

Source: Federal Reserve Bank, as at 30 April 2015. Past performance is no guarantee of future results. Please see the end for important legal disclosures

Of course, economic and financial conditions were very different during each of these episodes, and a set of factors unique to that time may have helped shape outcomes. In an effort to cancel out some of this variation, I've used averages across the four periods. 

The chart below shows the average response of large and small cap stocks to the last four periods of rising rates.  Both indexes were adversely affected by a rate rise in the first few months.  Small caps dipped further than large caps, at least initially, but then tended to recover more sharply than large caps after a few months.

 

Source: FTSE Russell actual historical data averaged over the following date ranges:  July 1986-July 1987, February 1994-February 1995, June 1999-June 2000, and June 2004-June 2005; indexes rebased to 100 at start of date range.  Past performance is no guarantee of future results. Please see the end for important legal disclosures.

When I ran the same analysis for large cap growth and value indexes, the pattern was somewhat similar but with some notable differences.  As illustrated below, while the Russell 1000 Growth Index typically took a significant hit in the early months following the start of a tightening period, it also snapped back sharply and recovered lost ground six months out.

 

Source: FTSE Russell actual historical data averaged over the following date ranges:  July 1986-July 1987, February 1994-February 1995, June 1999-June 2000, and June 2004-June 2005; indexes rebased to 100 at start of date range.   Past performance is no guarantee of future results.  Please see the end for important legal disclosures.

Value, by contrast, on average had a milder negative response and snap back, but it also recovered lost ground about six months out. This is in line with growth stocks’ reputation for being more sensitive to short term economic conditions, while value stocks are more driven by long term characteristics.1

The key takeaways from this experiment are perhaps best summarized in the table.  All of the indexes on average were negatively impacted in the first few months of a rising rate environment, but all fully recovered within six months.  Small caps were initially more adversely affected than large caps.

Average Responses to Rate Rises

Russell 1000

Russell 1000 Growth

Russell 1000 Value

Russell 2000

Russell 2000 Growth

Russell 2000 Value

3 Months

-1.67%

-3.04%

-0.40%

-3.58%

-5.11%

-2.22%

6 Months

8.73%

10.03%

7.06%

7.06%

9.46%

4.11%

12 Months

14.43%

17.45%

10.80%

11.50%

13.09%

9.41%

  Source: FTSE Russell actual historical data averaged over the following date ranges:  July 1986-July 1987, February 1994-February 1995, June 1999-June 2000, and June 2004-June 2005; indexes rebased to 100 at start of date range.  Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Growth had a sharper negative reaction than value in the first few months as well.

Of course, whether or not this is a useful guide can only be determined when the long,long drum roll finally stops and the Fed finally announces that it is beginning to raise rates.

 

[1] Koenig, D., “Growth and Value: The Beatles and the Stones,” Russell Index Insight, 2015.

 

© 2015 London Stock Exchange Group companies.

London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.

“FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under license.

All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.

Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put.

The London Stock Exchange Group companies do not provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a license with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.

Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.

Blog Listing Page