Who Wins When the Fed Hikes in December?

According to the Bloomberg World Interest Rate Probability function, the current implied probability for a fed funds rate hike in December remains high at 77% (as of October 11, 2017).  If this happens, it will be the third year in a row in which the Federal Reserve (Fed) increases rates in December; however, a December rate increase historically has not been that common. Looking at historical data going back to 1978, the first year for which data for Russell indexes is available; there were eight instances when the Fed increased its target rate for fed funds at its December meeting.

Today we look at opportunities in the stock market following a fed funds rate hike in December. Key economic data are listed below along with the corresponding interest rates in order to help better define the economic conditions of the era (Figure 1):

The data above shows that stocks were higher over the next 3 to 9 months (Figure 2), on average, following a December rate increase. Of the 10 major U.S. stock indexes analyzed; the Russell 2000 small cap indexes (including growth and value tilts) tended to exhibit the highest average returns of the sample:

As we move toward the end of the year and progressively closer to the December FOMC meeting, media speculation of how stocks will react if the Fed hikes rates will likely persist. Historical data suggest that equities in general tend to move higher following a rate increase in December; and it is likely that the small cap area of the market may fare even better than broad-based stocks, potentially uncovering an investment opportunity in this asset class going into the new year.

Stay tuned to the LPL Research blog for further updates on the stock markets.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The economic forecasts set forth in the presentation may not develop as predicted.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.

Stock investing involves risk including loss of principal.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Because of their narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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Consumer prices (CPI) are a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.

The unemployment rate tracks the number of unemployed persons as a percentage of the labor force (the total number of employed plus unemployed). These figures generally come from a household labor force survey.

Gross domestic product (GDP) measures the final market value of all goods and services produced within a country. It is the most frequently used indicator of economic activity. The GDP by expenditure approach measures total final expenditures (at purchasers’ prices), including exports less imports. This concept is adjusted for inflation.

The federal funds rate is the short-term interest rate targeted by the Federal Reserve’s Federal Open Market Committee (FOMC) as part of its monetary policy. In December 2008, the target “fed funds” level was replaced by a target range, and this ticker represents the upper bound of that range, while the ticker  FDTRFTRL Index DES<GO> provides the lower bound of that range.

The Russell 3000 Index is composed of 3000 large U.S. companies, as determined by market capitalization. This portfolio of Securities represents approximately 98% of the investable U.S. equity market. The Russell 3000 Index is comprised of stocks within the Russell 1000 and the Russell 2000 Indices. The index was developed with a base value of 140.00 as of December 31, 1986.

The Russell 1000 Index consists of the largest 1000 companies in the Russell 3000 Index. This index represents the universe of large capitalization stocks from which most active money managers typically select. The index was developed with a base value of 130.00 as of December 31, 1986.

Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The index was developed with a base value of 200 as of August 31, 1992.

Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The index was developed with a base value of 200 as of August 31, 1992.

The Russell 2000 Index is comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 total market capitalization. The index was developed with a base value of 135.00 as of December 31, 1986.

Russell 2000 Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

Russell 2000 Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.

Russell Midcap Index measures the performance of the 800 smallest companies in the Russell 1000 Index, which represent approximately 25% of the total market capitalization of the Russell 1000 Index.

Russell Midcap Growth Index measures the performance of those Russell Midcap companies with higher price-to-book ratios and higher forecasted growth values.

Russell Midcap Value Index measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values.

All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly

Tracking # 1-655018  (Exp. 10/18)