A tour bus passes the United States Federal Reserve Board building (rear) in Washington Oct. 28, 2014.Gary Cameron/Reuters
Equity investors are focusing on the Federal Reserve's FOMC meetings next Wednesday and Thursday.
Will the Federal Reserve increase its Fed Fund rate currently at 0.00 per cent to 0.25 per cent for the first time in 11 years?
Economists are divided on timing of the first increase: Half are expecting an announcement next week and most of the remainder are expecting an announcement before the end of the year.
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 per cent per period. It could be argued that the 13th occasion already has occurred. The S&P 500 Index dropped 12.5 per cent from its high on July 20th at 2,133 to its low on Aug. 25th 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
Oct. 29 1980 0.9
July 24 1984 14.1
Dec. 4 1987 11.8
April 4 1994 (4.2)
April 11 1997 16.6
May 27 1999 4.5
Aug. 12 2004 9.4
Mean Average 7.8
Median Average 9.4
Equity investors are watching closely for the Federal Reserve's decision and press conference scheduled next Thursday at 2 p.m. ET. The first increase in the Fed Fund rate at that time 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 near the end of the year matching the historic period of seasonal strength by North American equity market between mid-October and the first week in January. 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, $195.85) for U.S. funds. Choices for Canadian funds include: iShares S&P/TSX 60 units (XIU-T, $20.22), Horizons S&P/TSX 60 units (HXT-T, $26.03) and BMO S&P/TSX Capped Composite units (ZCN-T, $18.43).
Disclaimer: Don Vialoux is author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds available at www.timingthemarket.ca. 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.
Don Vialoux