Investors often associate Federal Reserve rate tightening with downside risk for equities, and with the central bank cruising toward its first rate hike of 2022 as soon as this month, some market participants are understandably pensive.
However, historical data indicate that rate hikes aren’t always a drag on equities, indicating that investors may not want to take their eyes off assets like the Invesco S&P 500 Equal Weight ETF (RSP).
“In theory, all else being equal, higher interest rates make equity investments less appealing, as they reduce the present value of corporate cash flows, and higher rates result in higher borrowing costs that eat into corporate earnings,” notes S&P Dow Jones Indices. “Consistent with such theories, the prospect of monetary tightening has triggered declines in U.S. equities, with the S&P 500® starting the year with its worst January since 2009. But history offers caution against assuming a rate hike would necessarily imply the end of the bull run.”
As the largest equal-weight exchange traded fund, RSP can mitigate some of the rate hike risk associated with cap-weighted equity funds. For example, RSP isn’t as heavily allocated to tech stocks, which, owing to future cash flows, can be vulnerable to rising rates.
The Fed’s most recent tightening cycles occurred in 1973, 1977, 1985, 1988, 1994, 1999, 2004, and 2015, and while stocks didn’t necessarily set the world on fire in those years, equities didn’t swoon, either.
“The S&P 500 underperformed, on average, compared to years that did not contain a first hike in rates. However, the average return remained positive and, more intriguingly, the performance differential narrowed after the current framework of monetary policy was adapted in 1994,” adds S&P Dow Jones.
Of course, past performance isn’t a guarantee of future results, but it’s widely known that the Fed will hike rates this year. To that end, RSP is lower on a year-to-date basis, but it’s outperforming the cap-weighted S&P 500 by nearly 300 basis points. That could be a sign that as investors consider equity positioning in a tightening environment, RSP could be a valid consideration.
“We may be even more foolish to ignore what our small sample tells us; the experiences of the past half century do not back the popular narrative that the start of a rate hike cycle necessarily goes hand in hand with broad-based losses for U.S. large caps. While we may be left with considerable uncertainty, whatever else happens, our sample size looks set to expand this year,” concludes S&P Dow Jones.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.