Yahoo Finance How Lofty Valuations Affect Stocks Following a Rate Hike
What a Rate Hike May Mean for Stocks
Valuations are key
The averages do hide a significant amount of variation in returns, and the direction of equity valuations at any given point in time also matters. Indeed, in the past, US equity markets have been more resilient to tightening monetary conditions if valuations were flat or lower over the preceding 12 months. But if valuations had been rising in the previous year, the S&P 500 has historically performed much worse following the start of a tightening cycle.
Market Realist: Lofty valuations and rate hikes affect stocks negatively
In the previous part of this series, we examined how markets react after tightening takes place. In this part, we’ll shine a light on how markets react to higher interest rates after multiple expansions or contractions.
In the three months following an initial rate hike, the S&P 500 (SPY) (VOO) has performed surprisingly better if valuations have been increasing over the past year, as the graph above shows. This is probably because the momentum that led multiples to expand carries on despite tightening.
Over the longer term, however, multiple expansion, coupled with tightening, leads to negative returns. In comparison, we see double-digit returns when the market is characterized by multiple contraction in the years preceding tightening. In these scenarios, the S&P has typically seen better returns in the six months and twelve months following tightening.
As we discussed in the previous parts of this series, the bull market is long in the tooth and has seen multiples expand since 2011. This could mean stocks could see subdued gains going forward.
The S&P 500 has underperformed global markets (ACWI)–notably Europe (FEZ) and Japan (EWJ)–in 2015. Rich valuations and tepid earnings growth due to the stronger dollar (UUP) are the main causes. Going forward, expect markets to be choppy.
Read on to find out which US stock segments seem most attractive.
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