Could an Interest Rate Hike Actually be Good for Your Portfolio?
The bear market "doomsday preppers" are out in full force.
And at face value, they have a reasonable argument. Our current bull market has reached historic duration. Surely the good times have to end at some point?
Greece is preparing to default on its debt obligations. That's a move that could send shock waves through global markets.
The U.S. economy is performing less well than expected thus far in 2015. The energy sector is still limping along.
Yet many observers say one development more than any other is likely to send your portfolio tumbling -- a decision by the Federal Reserve to raise interest rates.
While the Fed is meeting in June, a final decision on a rate hike is expected to come in September. Almost no one expects rates to stay the same.
What will be the true outcome of an interest rate hike?
Why is a hike all but inevitable? Because the U.S economy has rebounded nicely in recent years and job growth has been trending up. These larger economic trends are a positive indicator the economy can sustain a rate hike.
Yet it's no coincidence that our historic bull market has run parallel with nearly seven years of rock bottom interest rates. Low interest rates create a very favorable landscape for the stock market. How favorable? Consider this: Since the last rate cut in 2008, the S&P 500 is up close to 150-percent.
Given this state of affairs, it's natural to be concerned about a potential market tailspin.
Yet that's not what the historical data tells us.
Fortune magazine recently took a look at stock performance following a Fed interest rate hike. The numbers are compelling. In the 12 months following the last rate hike in a cycle, the market has outperformed its 12-month rolling average. The average return during this post-hike year is a healthy 14-percent.
Now, it's true that stocks do a bit worse during the actual cycle. Yet the damage is relatively limited. The S&P 500 has posted a weighted average compound annual growth rate of more than eight-percent during the last eight periods of rising rates. Volatility, too, has been lower than average during six of these periods.
There's more good news. Stocks have performed very well during rate hike cycles that began with very low rates -- much like those of today. The worst time for stocks? The six months preceding a rate hike.
Given the S&P's meager returns this year, that would seem to match up with well with prevailing conditions.
What this means for your portfolio
Rather than fall prey to rate hike market paranoia, investors should take a clear look at the evidence. Those who do will discover that rate hikes are not market poison. Most turbulence is short-term and leads to better returns down the road.
It's also important to remember that a rate hike is but one event. Many other factors will determine the market's performance. High stock valuations, European economic sluggishness and debt bubbles, just to name a few.
If you're concerned about a rate hike doing serious harm to your portfolio, take comfort in those facts. Historical data -- and common sense -- shows we have little reason to panic.