Russ Mould, investment director at AJ Bell, comments:
“This year could see the latest test of the old saying “three steps and a stumble” as the US central bank considers the timing of the third hike of this upcycle.
“Market lore has it that the third interest rate increase of a cycle is the one that really starts to start share prices, as increased returns on cash and rising bond yields start to tempt investors away from equities.
“Analysis of the seven rate increase cycles seen in the USA since 1970 suggests the old saying has more than a grain of truth in it, something that should put investors at least on a state of alert as America’s S&P 500 flirts with new record highs and US stocks trade at near peak valuations on market-cap-to-GDP basis.
“The data clearly show that the S&P 500 has historically traded strongly into the first rate hike but then has lost momentum as monetary policy has been tightened making little or no progress, on average, for the 12-month period that followed increase in headline US borrowing costs.
Market response: S&P 500 Composite index
Before first rate hike
After third rate hike
Source: Thomson Reuters Datastream
“Besides the fact that history is no guarantee for the future, bulls of US equities can take solace from three other trends:
“First, the Fed is increasing rates incredibly slowly. The average time span of the first three hikes over the past seven cycles has been 165 days, whereas it has already taken the Yellen Fed 411 days to manage just two.
“Second, the Fed is hiking from a very low base. Prior rate cycles started at an average of 4.48% and ended at 5.57%, compared to the zero-to-0.25% starting point this time around.
“Third, the S&P 500 has tended to regain its footing within two years, presumably in the view that the Fed was hiking because the economy was strong and corporate earnings were moving sharply higher.
“For the moment, the market is putting a 4% chance on a Fed rate rise on Wednesday, a 44% chance on an increase by June and only a 24% chance of the central bank delivering all three of its targeted hikes, which would take rates to the 1.25% to 1.50% range.”
Source: CME FedWatch, 30 January 2017