How do equities perform around the U.S. Federal Reserve tightening cycle?

At the moment there is only one discussion taking place among investors – how many times will the U.S. Federal Reserve raise rates in the current cycle?

Rather than try to forecast how many times the U.S. Fed will lift rates, the data and information below provides some historical context as to how equities (using S&P 500 Index as a proxy) performed during the previous five tightening cycles – 1987- 1989, 1994 – 1995, 1999 – 2000, 2004 – 2006 and 2015 – 2018.

The data is collated by S&P Global and we have produced the information below. In the charts below, S&P 500 represents equities, ICE BofA U.S. High Yield Index represents high yield and LSTA Leveraged Loan represents leveraged loans, which have become popular over the last ~20 years.

Not a good track record and hence the commonly used term “policy mistake”. As the data shows and noted by S&P Global, the initial weakness in equities on the back of an imminent tightening cycle eventually saw equities higher in most cases – ” early weakness almost always gave way to rallies: equities were higher at the end of all five periods, leveraged loans were higher after the three periods that were tracked, and high-yield was higher four times and down just 3% the fifth. It is also notable that the economic braking action of a rising Fed funds rate in those periods did not immediately translate into declines in gross domestic product. Although recessions followed four of the rate-hike periods, the official start of each was, on average, more than one year after the final hike.”

+ Tightening cycle #1: 1987 – 1989. Equities were higher one year later after the last rate hike. However, it is worth keeping in mind that the last rate hike was in May 1989 and markets experienced the October 1987 stock market crash post that. It is said that the crash was caused by computer program driven models and subsequent investor panic.

+ Tightening cycle #2: 1994 – 1995. Equities were higher one year later and no recession followed the tightening cycle.

+ Tightening cycle #3: 1999 – 2000. Equities actually increased during the hiking period, but were lower one year later. However, following the last rate hike, the NASDAQ composite lost more than 80% and S&P 500 lost more than 40% over two years post the tech crash of 2000.

+ Tightening cycle #4: 2004 – 2006. Equities rose during the rate hike period and were higher one year later post the last rate hike. Equities peaked in October 2007 and subsequent to this we had the GFC (Global Financial Crisis).

+ Tightening cycle #5: 2015 – 2018. The U.S. Fed started to increase rates from Dec 2015 and finished the hiking cycle in December 2018. Worth noting this tightening cycle followed 7 years of near zero fed funds rate. Further, the tightening cycle ended in Dec-18 when the S&P 500 index fell -19.8% from its high in Sept-18 to lows in late Dec-18.

What is also worth highlighting is where the Fed Funds rate topped out during each tightening cycle:

#1: 1987 – 1989 = 9.81%
#2: 1994 – 1995 = 6.00%
#3: 1999 – 2000 = 6.50%
#4: 2004 – 2006 = 5.25%
#5: 2015 – 2018 = 2.25%

and now…

#6: 2022 (first rate hike expected @ Mar-22 meeting) – ??? = ???

and

S&P 500 Index (USD) is down -5.94% CY22 YTD to 16 Feb-22 (we haven’t even started hiking yet!)

Further, in each of the 5 tightening cycles presented above, the Fed Funds rate was always lower one year after the last rate hike in the respective cycle.