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Interest Rates & War: What Does Historical Precedent Tell US?

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The two most significant topics on investors’ minds are interest rates and geopolitical escalations. For each of these topics, investors must understand that markets tend to act counterintuitively to each of these market factors. Using historical data and other market factors, I break down each in a historical context below.

Interest Rates

Higher Interest Rates Can Help the Consumer

High interest rates have a terrible reputation for the stock market, but they can also help the U.S consumer. For the past year or so, Americans have been piling into money market accounts, and their balances are near all-time highs. Though interest payments have spiked, they are counterbalanced by a leap in interest income in money market accounts.

Are Rate Cuts Really that Bullish?

Savvy investors understand that bull markets are built on liquidity. Because the U.S. Federal Reserve and Jerome Powell control the most liquidity, investors understandably key into every FOMC meeting. Nevertheless, the irony is that historical data shows that markets like discount future rate cuts ahead of time and tend to like the idea of a rate cut more than the rate cut itself. The table below shows the market’s performance after the first rate cut. Six-month returns are mediocre at best, with the S&P 500 lower six months later after a rate cut 4 of 9 times with an abysmal return of just 3.4%.

Zacks Investment Research
Image Source: Meeder Investment

Meanwhile, a look at how the market has acted in the face of a “hawkish” Fed is the perfect example of why common thinking about monetary policy is misled.

Zacks Investment Research
Image Source: Fisher Investments

Rates & The Economy

Though inflation is a factor in delaying rate cuts, it can also mean that the Fed believes that the economy is strong and does not require any accommodative Fed policy. For example, personal consumption expenditures (comprising nearly 70% of GDP) recently notched a record high while GDP has trended higher since dipping during the brutal bear market of 2022.

Geopolitical Escalations in the Middle East

After months of depressed volatility, stocks are in a classic “headline-driven” environment due to escalations in the Middle East. Though telegraphed, Iran fired a barrage of missiles and unmanned drones at Israel over the weekend. Fortunately for Israel, the “Iron Dome” blocked around 99% of the offensive, and few injuries were reported. Despite the lack of impact, the news is significant. Iran has conducted attacks for years through proxies. However, now that Iran has directly attacked Israel, it is a clear escalation in the conflict between the two countries. The conflict is likely to get worse before it gets better – the Israeli Air Force has reportedly completed its preparation for an imminent attack against Iran.

Short-Term Bearish, Long-Term Bullish

Like interest rates, Wall Street’s interpretation of war and stocks and the historical reality of it often differ. History tells us that geopolitical escalations tend to cause an initial shock lower in equities but later provide an opportunity in the intermediate to long term.

Zacks Investment Research
Image Source: Zacks Investment Research

Beyond historical data, investors should look at defense stocks such as Raytheon ((RTX - Free Report) ) and Northrop Grumman ((NOC - Free Report) ) for clues.On the interest rate side, investors can track the Gold ETF ((GLD - Free Report) ) and Silver ETF ((SLV - Free Report) ) as well as the interest rate-sensitive Russell 2000 Index ((IWM - Free Report) ).

Bottom Line

Investors who study historical precedent may be surprised with their findings regarding the relationship between, interest rates, war, and stocks. Rate cuts are not necessarily bullish, and war is not necessarily bearish.

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