Next week, the Federal Reserve will hold its final meeting of 2016. Throughout the year, most investors have assumed that this December meeting will result in another interest rate hike; however, Donald Trump’s upset victory in the presidential election caused many to question whether a new hike would come at all.
President-elect Trump is not the most outspoken supporter of Fed Chair Janet Yellen, but his campaign did announce that it would not seek her resignation shortly after his victory. Furthermore, despite the uncertainty that Trump’s win was expected to cause, the markets adjusted quickly and a rate hike still seems to be on track.
With that said, investors need to be ready for next week’s Fed meeting and the interest rate hike that we will probably see. Many investors tend to assume that stocks will decline after rate hikes, but that’s not always true, and savvy traders will be as informed as possible.
Rate Hike Cycle Trends
Fed interest rate hikes make it more expensive to borrow money, which can cause consumers and businesses to cut spending. While this pattern could have an impact on earnings, this is not a set-in-stone trend that results in declining share prices.
In fact, according to data from Option Alpha, rate hike cycles have historically presented investors with some strong opportunities to buy. Option Alpha looked at six instances between 1983 and 2004, ultimately finding that stocks were up in four out of six cycles 250-days after the hike, for an average return of 2.6%. If that window gets expanded out to 500-days after the hike, we see five cycles with positive returns for an average gain of 14.40%.
Option Alpha noted that the best industry after these cycles was the Energy industry, while the worst-performing industry was Telecom Services. Check out Option Alpha’s infographic for the full details, including bond performance:
In short, it is incredibly difficult to predict the performance of the stock market based simply on whether interest rates are rising or falling. Overall returns during rising rates years are slightly lower than during declining rates years, but the worst years during the 2000s occurred when rates were going down. It’s not entirely consistent.
Heading into next week’s Fed meeting, smart investors should steer clear of reactionary trading, and instead, they should focus on the fundamental strength of the economy, as well as the strength of individual stocks that hold strong Zacks Ranks.
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Option Alpha is an online education platform that specializes in options trading. What started as a small personal blog has quickly grown into one of the industry's most respected authorities on options trading and more than 6.4 million visitors each year and 35,000 active members representing 42 countries.
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