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Mortgage News You Can Use Rising rates not all bad for investorsBy Rachel Beck, AP Business Writer, 2/5/2004 NEW YORK -- Investors see the prospect of rising interest rates as only bad news. But it doesn't have to be. A look back in history shows that in times when the inflation rate was low, stocks have rallied in the months following the Federal Reserve's tightening of interest rates. It's when inflation has started out high and kept growing as rates went up that markets have slumped. So with inflation very tame right now, maybe the doomsday predictions for stocks in a higher rate world are a bit overblown. All it took was the Fed's hint last week that its policy stance on interest rates could be shifting to stir up worries on Wall Street over what this could do to stocks. Since August, Fed policy-makers had been saying they foresaw holding rates low for a "considerable period," which investors interpreted to mean next year. But that language was deleted from its latest statement, and the Fed now says it "can be patient in removing its policy accommodation." Many economists believe a change is coming by summer's end. The Fed's key short-term interest rate, called the federal funds rate, stands at a 45-year low of 1 percent, where it has been since last June. The Fed began lowering rates in January 2001. Any increase in the funds rate would mean a similar boost to commercial banks' prime lending rate, which is the benchmark for many short-term consumer and business loans. And that has investors concerned about how rising borrowing costs could dent corporate profits and decrease the underlying values of stock. But higher rates don't necessarily lead to lower stock prices. Sure, if you look at the effect of the five times the Fed initiated rate increases between 1973 to 1999 on the Standard & Poor's 500 index, it paints a negative outlook. The market went from being up 3.63 percent on average three months before the Fed's moves to down 6.91 percent six months after, and it remained down 3.92 percent a year later, according to a new report by Prudential Equity Group. But that isn't the case when you look at the returns after the four initial Fed rate increases from 1955 to 1967. Instead of suffering market declines, investors actually prospered during those times. The S&P 500 went from being up 3.07 percent on average during the three months before the rate change to gaining 13.12 percent after six months and 20.22 percent a year later, Prudential said. So why the drastic difference? The answer has to do with inflation. While average change in the unemployment rate and economic growth were about the same during both periods, inflation was much lower in the 1950s and 1960s, when the market rose after the Fed's tightenings. The average inflation rate during the earlier period was 1.53 percent at the time of initial interest rate hikes, and it only climbed to 1.7 percent a year later. That's a sharp contrast to the last three decades, Prudential notes, when the average inflation rate was 3.96 percent at the time of Fed tightenings, and rose to 5.68 percent a year later. "This shows that the Fed was not infallible" from 1973-1999, said Edward Keon, Prudential's chief quantitative strategist who authored the report. "It managed to slow the rate of economic growth, but didn't stop inflation, and that is the worst of both worlds. The market hates to see that." That's why Keon thinks investors shouldn't be afraid of the Fed now. With current inflation trending under 2 percent, the market could easily keep moving ahead. Of course, this is Wall Street, where there's no telling what will happen when rates do go up. But at least investors should have some hope that there could be good times ahead. Back to Original Article: Mortgage News You Can Use
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