Do rate hikes always lead to poor market returns?

With the US Federal Reserve (Fed) expected to raise interest rates soon, we examine the performances of the US and Emerging Markets during the four most recent extended rate hike cycles in 1994, 1999, 2004 and 2015. In these rate hike cycles; interest rates went up between 175 to 425 basis points. Looking at the 12-month returns following the first hike in each of this episode, it appears that it is not a foregone conclusion that rate hikes always lead to poor market returns. During these four rate hike cycles, there have been instances where the Emerging Market and Asian markets delivered positive returns, and at times, outperformed the US market. This goes to show that every rate hike cycle is different, and many other local factors can come into play to influence the market’s performance. At the same time, the rate hike cycle which the Fed is planning to embark on may also be less straightforward, given the market volatility brought about by the Russian-Ukraine situation.

Importantly we note that this time round, Asian central banks may not follow in the Fed’s rate hiking footsteps immediately, or with the same pace. Asian inflation is still relatively benign, and many Asian central bankers tend to view price pressures, especially those caused by rising commodity prices as a tax on growth.

Hence, they are more likely to look through such price pressures. The Reserve Bank of India for example recently kept interest rates on hold to support India’s growth recovery. At the same time, potential easing in China may offset the negative impact from US rate hikes. 

Ultimately, besides the rate cycle, earnings and valuations matter, and stock pickers can add significant value in identifying companies that are more defensive when rates rise. Historically, value sectors such as financials, materials and utilities tend to fare better in a rising rate environment. As such, value strategies appear attractive especially since valuations are compelling following an extended period of underperformance.

Meanwhile, the MSCI Asia ex Japan Minimum Volatility Index showed that low volatility stocks were able to participate in the upside when the market rose in the 2004 rate hike cycle1, while their decline was relatively muted in the 2015 rate hike cycle. If we expect market volatility to rise in the coming months on the back of rising geopolitical uncertainty and ebbing global liquidity, low volatility stocks may be a welcomed addition to investors’ portfolios.

Market performance in recent extended rate hike cycles

Tabular data of Market performance in recent extended rate hike cycles

Source: Bloomberg. 14 February 2022.

1 Older data not available due to the start date of the MSCI Asia ex Japan Minimum Volatility Index.

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