Equity investors are focusing on the Federal Reserve's FOMC meetings on Dec. 16.
Will the Federal Reserve increase its Fed Fund rate for the first time in 11 years? Most economists believe so.
The first increase in the Fed Fund rate historically has had a significant impact on equity markets, both before and after the event. Since 1955, the Federal Reserve reversed its interest rate policy with an increase in the Fed Fund rate on 12 occasions. Equity investors anticipated a negative response during the six month period prior to the first increase.
Net result: the S&P 500 Index recorded 12 consecutive corrections averaging 10.0 per cent per period.
Assuming that the Federal Reserve increases the Fed Fund rate next Wednesday, the 13th consecutive occasion occurred last summer: The S&P 500 Index dropped 12.5 per cent from its high on July 20 at 2,133 to its low on Aug. 25 at 1,867.
The S&P 500 Index also has a history of moving higher after the first increase in the Fed Fund rate is announced. On average during the past 12 periods, the S&P 500 Index during the next three months gained 10.9 per cent per period. Following is the data:
| Date of first rate hike | % gain after 3 months |
|---|---|
| March 14 1955 | 13.5 |
| March 5 1968 | 14.4 |
| May 26 1970 | 17.2 |
| Nov. 23 1971 | 16.9 |
| Oct. 3 1974 | 13.5 |
| Oct. 29 1980 | 9.3 |
| July 24 1984 | -1.7 |
| Dec. 4 1987 | 19.4 |
| April 4 1994 | 1.7 |
| April 11 1997 | 24.3 |
| May 27 1999 | 5.2 |
| Aug. 12 2004 | 11.4 |
| Mean average | 10.9 |
| Median average | 13.5 |
Gains also were significant during the next three months for the TSX Composite Index.
Data from 1980 shows the following:
| Date of first rate hike | % gain after 3 months |
|---|---|
| October 29 1980 | 0.9 |
| July 24 1984 | 14.1 |
| December 4 1987 | 11.8 |
| April 4 1994 | -4.2 |
| April 11 1997 | 16.6 |
| May 27 1999 | 4.5 |
| August 12 2004 | 9.4 |
| Mean Average | 7.8 |
| Median Average | 9.4 |
The first increase in the Fed Fund rate since 2004 likely will be the starting point for North American equity markets to move higher. Negative investor anticipation of the event finally will be relieved. The stage will be set for a period of strong equity markets lasting until at least spring. Economists are talking about "a one and done" increase in the Fed Fund rate this time, implying likelihood of an extended period of stable interest rates following the first increase.
Traders and investors can take advantage by owning a wide variety of U.S. and Canadian equities and broadly based Exchange Traded Funds following the rate hike announcement. ETF examples include S&P 500 SPDRs (SPY-N) for U.S. funds. Choices for Canadian funds include iShares S&P/TSX 60 units (XIU-T), Horizons S&P/TSX 60 units (HXT-T), BMO S&P/TSX Capped Composite units (ZCN-T) and First Trust AlphaDEX Canadian Dividend Plus ETF (FDY-T)
Don and Jon Vialoux are authors of free daily reports on equity markets, sectors, commodities, and Exchange Traded Funds. Daily reports are available at http://TimingTheMarket.ca/ and http://EquityClock.com. The enclosed report is for information only. It should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.