Oxstones Investment Club™By Steven Russolillo, WSJ Blog,
With the focus shifting to when the Federal Reserve will start raising short-term interest rates, Goldman Sachs Group Inc. offers a road map for investors on how stocks perform before and after such a move.
The analysis comes as the Fed’s policy-setting committee gets set to gather this week. All signs indicate the central bank will talk more concretely about when it will raise rates, either in its post-meeting statement or through Chairwoman Janet Yellen‘s news conference.
Most investors expect the Fed will wait until sometime in the middle of next year before acting. For bulls, the good news is stocks tend to rally in the three, six and 12-month periods leading up to the Fed’s first interest rate increase. The average performances after the Fed makes a move aren’t as bullish.
“Some investors believe the 2004 tightening episode is most comparable to the current yield environment and therefore serves as the most relevant guide to how stocks will behave in advance of the next tightening,” David Kostin, chief equity strategist at Goldman, wrote to clients, building upon a previous report in that compared how stocks and Treasurys perform leading to a rising-rate environment.
“As in 1994 and 1999, the 2004 experience suggests the S&P 500 will rise during the next 12 months, cyclical sector leadership, and low valuation outperformance relative to high valuation stocks.”
In the three prior instances the Fed started raising rates, the S&P 500 has averaged a 3% gain in the three months prior to the first rate increase, according to Goldman. By comparison, it averaged a 4% drop in the three months following such a move.
The average returns are similar in the six months before and after the Fed first raising rates
In the 12-months prior to the Fed first raising rates, the S&P 500 has averaged a 17% gain, compared to a 6% average increase 12 months after such a move, according to Goldman.
Of course the past isn’t necessarily indicative of future performance. The economy is in a much different state now than it was back in 1994, 1999 and 2004.
But as Goldman puts it, these historical comparisons offer a “relevant guide” to what could happen next.
“Precedent shows cyclical positioning outperforms during the three, six, and 12 months ahead of a tightening,” Mr. Kostin said. “Low valuation and low momentum stocks outperform their high valuation and high momentum counterparts.”
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