Every time the Federal Reserve embarks on a new cycle of interest-rate cuts or hikes, market watchers warn investors, “Don’t fight the Fed!”
The belief is that higher rates heighten the competition stocks face from other investments, most notably bonds. They also make it more expensive for companies to finance their operations, payroll and purchases, which tends to reduce profits and undermine stock performance. (Lower rates have the opposite effect.) Ergo, investors should reduce their exposure to equities during the Fed’s current campaign to boost short-term rates—right?
Not exactly, says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., Inc. “In fact, stocks have generally done well during most rate-hike cycles,” she says (see “Hand in hand,” below).
Whether investors should cut back on equities could depend on multiple factors, including why the Fed is tightening its policy. “If the Fed is repeatedly raising rates in an attempt to bring inflation under control—as was the case during the 1973–1974 rate-hike cycle—then it can be a very negative environment for stocks,” Liz Ann says. “But in the current climate, in which rates are rising but remain low by historical standards, equities should continue to benefit, at least in the short term.”