Will the Market Crash if the Fed Raises Interest Rates?
Almost every day as I drive home from work, I hear the same commercial on the radio. It starts off with "Is your retirement account likely to drop 60% during the next market crash? Everyone knows that the market is bolstered up by the Fed's low interest rates... and if you're in the stock market, you stand to lose 20, 30, 50 percent - or even MORE of your hard earned retirement account when interest rates start to rise! Instead - invest in safe and secure GOLD - in your IRA - today by calling _________."
Wow. Just... wow. I mean - first of all, Gold is one of the MOST volatile substances an investor can own - especially in an investment account. Let's conveniently not mention that it is DOWN 37% over the last 3 years, while the stock market has gone up and up during the economy's recovery after the last recession. Let's also pretend that the total real return on Gold since 1802 is about 3.32% (that's TOTAL, not compounded) - with nearly as much volatility as stocks and certainly more volatility than investment grade bonds...
But I guess what also smokes my shorts is that seemingly everyone buys into the concept that the stock market is "bolstered up by low interest rates." Is this a buzzword, or just something that became popular to say, like back in the '80's when it was popular for California girls to say "Gag me with a spoon," or "Totally?" Whence came the idea that the stock market plummets when interest rates rise?
Taking a quick look back at the history, we find that, in general, the Fed raises interest rates during the latter phases of the economic cycle - after a post-recession recovery has run its course, and the economy seems to be up and running pretty much as well as it can. Generally, recessions occur approximately every 8 to 12 years - and the Fed typically will lower interest rates in order to soften the recession's blow and to boost the economy again. So... as of this writing; we are 6 years into the recovery and almost 8 years from the beginning of the last recession. The Fed knows that they need to get interest rates back up to a "normal" range (about 5% or so) in order to have any meaningful impact to the economy when the next recession occurs.
So, during the previous time periods... when the Fed raised interest rates - did the stock market crash? Well, all we have to do is peek into the history books and find out. According to Standard and Poors... no, there is no historical evidence that an increase in interest rates causes the market to tank.
6/2004 - 6/2006 S&P returned 7.81%
6/1999 - 5/2000 S&P returned 9.86%
2/1994 - 2/1995 S&P returned 0.67%
3/1988 - 2/1989 S&P returned 15.09%
12/1986 - 9/1987 S&P returned 35.35%
In fact, of all of the "normal" asset classes a typical investor would choose from to build a portfolio (Treasuries, Corporate Bonds, High Yield Bonds, or Stocks) we find that the highest returning asset class during interest rate increases has historically been.... drum roll... you guessed it! Stocks.
As I write this (September 2015), I cannot predict if the Fed will raise interest rates this week or not. But I will make a wager with anyone who wants to take it, that the world will not end, that the global markets will not "crash" 60%, and that a year from now investors will look back and find that the best thing they could have done was... the most boring thing... strictly maintained their investment policy, and remained fully invested in a portfolio professionally designed, specifically for their needs and their risk tolerance... which, more than likely... will include a healthy dose of the stock market.
Jon Castle serves as Chief Investment Officer for PARAGON Wealth Strategies, LLC. Please see his bio here: Jon Castle
Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by PARAGON Wealth Strategies, LLC), will be profitable or equal any historical performance level(s). For additional disclosures please click here: Disclosures
Sources: Federal Reserve Bank of New York, Citigroup, Barclays, BofA Merrill Lynch, and S&P Dow Jones Indices. Two-Year U.S. Treasury = Citi Treasury Benchmark 2-Year Index. 10-Year U.S. Treasury = Citi Treasury Benchmark 10-Year Index. Barclays Aggregate = Barclays U.S. Aggregate Bond Index. Short Corporate Bonds = The BofA Merrill Lynch 1-3 Year U.S. Corporate Index. Floating Rate Loans = Credit Suisse Leveraged Loan Index (historical data for this index is monthly; returns reflect nearest month-end). High Yield Bonds = BofA Merrill Lynch High Yield Index. S&P 500 = S&P 500 Index.