How Might Stocks Take a Hike?

Though the Federal Reserve continues to show extreme caution about rate increases, the expectation is that policy will move in that direction sometime next year. This prospect prompts a look here at how stocks have behaved during past such interest-rate moves and, by implication, how they might behave this next time. As is so often the case, the historical record is far from clear. Still, the patterns that do exist, amid other indicators, suggest little reason to abandon equities in anticipation of such a move, and within stocks, also suggest a bias toward growth and more economically sensitive sectors.

When Rates Rose
The available data permit a look at six times in the past when the Fed permitted a significant up move in short-term rates. Table 1 outlines these:

Table 1. Federal Reserve Rate Hikes

Periods of Increase

Low Rate

High Rate

Total Move
(basis points)

Rate of Increase
(basis points)

1.  Mar. 1972–Aug. 1974




21 bps

2.  April 1977–May 1981




22 bps

3.  Oct. 1986–Mar. 1989




13 bps

4.  Sept. 1993–Jan. 1995




18 bps

5.  Oct. 1998–May 2000




10 bps

6.  Jan. 2004–Feb. 2007




11 bps

Source: Federal Reserve Board. A basis point is 1/100 of a percent.

Overall Market        
If this history is any guide, the prospect of rising rates should hold no fear for equity investors, at least not initially. Though stocks (as measured by the S&P 500® Index1) often suffer a sharp drop when rates first begin to rise, such setbacks usually dissipate quickly, no doubt because the Fed tends to push up rates when the economy and earnings are growing. The figures vary so much from one instance to the next that averages would be meaningless. But it is well documented that stocks in the past have provided positive total returns on balance for at least four quarters or more after rates begin to rise (other time periods may have been negative). The danger for equities emerges later in the Fed’s tightening phase, no doubt because economic weakness and often recession typically result from the cumulative effect of the increases. Two of these six instances offer an even more encouraging exception. In the late 1980s and early 1990s, the up moves in equities persisted on balance throughout the period of rising rates.     

If this record applies to the future—and there is every reason to believe it may—equities still have room to advance even as the Fed enacts its policy change. Reinforcing this expectation are the still-attractive valuations offered by equities and the prospect that economic growth, and so too earnings growth, though slow, should continue. In contemplating this likelihood of stock gains even after the Fed begins to raise rates, investors also would do well to remember that, according to the Fed’s own statements, the policy change likely will not begin until next year, leaving potentially more room for gains in the interim.    

Allocation Among Equities
When it comes to decisions on style, the historical picture offers little guidance, at least on the surface. Value stocks outperformed growth stocks in the first three of these periods of rate increases, while growth outperformed value during the two instances of rising rates in the 1990s. In the most recent period of rate increase, between 2004 and 2007, value again outperformed growth. While this seems like a truly mixed bag, a look at what else was happening during these periods can provide some sense of order and also a reason that growth has the potential to outperform during this next round of rate increases. [Although due to market volatility, the market may not perform in a similar manner in the future.]  In the 1970s, for example, inflation was an overriding consideration and with it a concern over the quality of earnings that drove investors to favor value over growth. In the first decade of this century, memories of the great tech and dot-com crash created a clear preference for value. Since neither of these matters seems likely to prevail this next time, growth would seem to benefit, especially since valuations now actually favor growth stocks.

This record is hardly conclusive on questions of whether to favor small cap or large cap stocks. In the early 1970s, large caps outperformed small caps as rates rose, but in the late 1970s and 1980s, it was the other way around. During the period of rate increase in the early 1990s, large took the lead, but small bested in the late 1990s—hardly a surprise in the tech and dot-com craze that dominated the time. During the one period of rate increase in this century so far, small outperformed large. Given this less than conclusive picture, it would seem, then, that the best way to proceed is to achieve a broad diversification across capitalization ranges. Fairly consistent valuations across classes argue the same way. 

Sector mix, too, presents a muddled historical picture, at least on the surface. In these past periods of increasing rates, no one major industry either leads or lags. That fact should hardly surprise, given how many other influences on relative sector performance operate, whether in periods of rate increase or decrease. 

So, for example, technology was the best performing sector during the two periods when rates rose in the 1990s. It also was the best performing sector during the periods of rate decline in the 1990s. Unsurprisingly, technology performed relatively poorly during the only period of rate increase so far in this century, no doubt as a reaction to the tech bust of 2000–02. While technology did its lead and lag, utilities, which would seem to be the anti-tech sector, did surprisingly well during the period of rate increase in the late 1990s, but fell, even as other stocks rose, during the time when rates rose in the early 1990s. Even financials, seemingly most closely associated with interest rates, have shown an inconsistent performance record. They were, for instance, the second worst performing major sector during the period of rate increase in the early 1990s, but were right in the middle of the pack during the period of the rate increase in the late 1990s and during the period of rate increase from 2004 to 2007. 

Extrapolating from such a muddle of specifics, it would seem that more economically sensitive sectors have done better in these past periods of rate increase than have other sectors. This stands to reason, since the Fed tends to raise rates when the economy is expanding.              

The Inevitable Bullet Points
From this historical analysis, it would seem, then, that investors, contemplating the Fed’s decision to begin raising rates some months from now, should be guided by these evident patterns:

    1. Equities have potential room to move up well into the period of increasing rate hikes.
    2. Chances are that growth stocks could lead value stocks into the period of rate increase.
    3. Capitalization is such an open question that it calls for a broad diversification on this count.
    4. If it is impossible to pinpoint sector winners and losers from past periods of rate increases, the record would seem to favor those that are economically sensitive.


Note: I would like to thank Robert Noelke, Lord Abbett Partner and Director of Investor Services, for suggesting this analysis.

1The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.Past performance is no guarantee of future results.

2All data herein from FactSet, unless otherwise noted.

Risks to Consider: Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Small cap company stocks tend to be more volatile and may be less liquid than large cap company stocks. Historically speaking, growth and value investments tend to react differently during the economic cycle. Since value stocks are often cyclical in nature, they may benefit from the increased spending that usually occurs during an economic expansion. Growth stocks may also perform well during an expansion, but they may also be out of favor during market downturns, when investors pay more attention to price ratios. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Small cap companies also may have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies.  Due to market volatility, the market may not perform in a similar manner in the future. No investing strategy can overcome all market volatility or guarantee future results.

Diversification does not ensure a profit or guarantee against loss.

Market forecasts and projections are based on current market conditions and are subject to change without notice.

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

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