As expected, the Fed raised short term interest rates by .25% yesterday. The Prime Rate is now at 3.5%. Big deal. It is an utterly meaningless and totally symbolic gesture. It will have little to no impact upon the mortgage market, which exists in the real world outside of total Fed control. Such an insignificant increase in rates after they have sat at zero for so many years means essentially nothing economically. That did not keep the financial gurus and economic pundits from proclaiming that it was the most momentous economic event of 2015 however. Some, like investment adviser Marc Faber, said it would usher in financial Armageddon. Others, like the infamous Jack Welch said that the Fed "had no other choice." cnbc.com promoted the Fed announcement like it was the most significant economic event since the Great Recession. I understand that all of these people and groups have self-interested axes to grind but come on people, use some common sense.
A good resource for developing common sense is history. Observing what has happened in the past is a good way to prepare for things in the future. It does not following that being aware of the past makes one capable of predicting the future. It does follow that being aware of the past can make one avoid looking stupid by making really dumb predictions.
Let's begin by considering the economy. It seems as if the popular wisdom is that when the Fed raises interest rates it chokes off economic growth and creates a recession. Most people believe this nonsense, despite the fact it is child's play to prove it wrong. Most people also believe the converse, that the Fed creates economic growth by cutting interest rates. The fact that economic growth in the Socialist Democracy of Amerika remains less than robust despite the Fed Funds Rate sitting at zero percent for the past nine years does not deter people from believing that myth. We are dealing with religious beliefs here and when it comes to the religion of state worship no amount of factual content can sway a true believer. Both positions on the Fed's manipulation of the interest rate are patently absurd but today I am only focusing on the first. Look at the chart below. It tells the entire story. "Fed Tightening" means raising interest rates. If raising interest rates creates recessions why is it that the last five periods during which the Fed raised rates had an average length of time to the next recession of almost four years? In 1994 the Fed doubled the rate of interest in a twelve month period. It took over seven years before the next recession started. I think we can put the notion that raising rates creates recessions to bed.
Although it is impossible to know exactly what motivates the short term mentalities of day traders in the stock market, much of the recent volatility has been attributed to one of two things. Some believe the stock market corrected by 12% earlier this year because of the collapse in the price of oil. Others believe that the stock market corrected by 12% earlier this year because of the anticipated Fed interest rate hike. Both beliefs are economic nonsense but the economic understanding of most day traders is the equivalent of a five year old being instructed by a Keynesian indoctrinated government school teacher so we should not expect much from them. The chart below shows what has happened to the Standard and Poor 500 stock market index after all interest rate hikes since 1946.
In all cases the stock market was higher six months after the first rate hike. In all cases the stock market was even higher still twelve months after the rate hike. The rate of growth in the stock market is somewhat lower than the average for all years after an interest rate increase whereas the rate of growth in the stock market is somewhat higher than average after an interest rate cut. We must remember that correlation does not mean causation. I suspect that there is some other emotional or economic factor in play here. The mere fact that day traders ignorantly respond positively to cuts and negatively to increases could explain the difference.
The graphic below tells essentially the same story. In all cases the average return is positive. In no case does an interest rate increase cause the stock market to realize a negative return. Indeed, one year after the Fed begins raising interest rates the average rate of return in the stock market is 12%, exactly equal to its historic long term average annual rate of return. One could almost say that the interest rate shenanigans pulled by the Fed really do not impact the stock market, in the long term, at all.
So the hike is done and we are all still here. The universe did not come to an end and all of the compulsive Fed watching that took place over the last year or so has proven to be a total waste of time. I hope you didn't get caught up in it. There were many more interesting things to do than watch the Fed. Remember this little lesson from history the next time a cycle of obsessive Fed watching takes place. When you see it happening go outside and take a walk. That will be good for both your portfolio and your health.