Get ready for the climb.

Here’s what history

says about stock-market returns during Fed
rate-hike cycles.
Last Updated: Jan. 16, 2022 at 12:22 p.m. ET First Published: Jan. 15, 2022 at 8:01 a.m. ET
By

Mark DeCambre

42

It’s been 30 years since U.S. 10-year yields rose this much to
start a year

U.S. Treasury yields are climbing again!

MarketWatch photo illustration/iStockphoto, FactSet

 Referenced Symbols

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ARKG
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ARKF
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GME
-4.76%
AMC
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PNC
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IBKR
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KEY
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Bond yields are rising again so far in 2022. The U.S. stock market seems vulnerable to a bona
fide correction. But what can you really tell from a mere two weeks into a new year? Not much
and quite a lot.

One thing feels assured: the days of making easy money are over in the pandemic era.
Benchmark interest rates are headed higher and bond yields, which have been anchored at
historically low levels, are destined to rise in tandem.
Read: Weekend reads: How to invest amid higher inflation and as interest rates rise

It seemed as if Federal Reserve members couldn’t make that point any clearer this past week,
ahead of the traditional media blackout that precedes the central bank’s first policy meeting of
the year on Jan. 25-26.

The U.S. consumer-price and producer-price index releases this week have only cemented the
market’s expectations of a more aggressive or hawkish monetary policy from the Fed.

The only real question is how many interest-rate increases will the Federal Open Market
Committee dole out in 2022. JPMorgan Chase & Co. JPM CEO Jamie Dimon intimated that
seven might be the number to beat, with market-based projections pointing to the potential for
three increases to the federal-funds rate in the coming months.

Check out: Here’s how the Federal Reserve may shrink its $8.77 trillion balance sheet to combat
high inflation

Meanwhile, yields for the 10-year Treasury note yielded 1.771% Friday afternoon, which means
that yields have climbed by about 26 basis points in the first 10 trading days to start a calendar
year, which would be the briskest such rise since 1992, according to Dow Jones Market Data.
Back 30 years ago, the 10-year rose 32 basis points to around 7% to start that year.

The 2-year note BX:TMUBMUSD02Y, which tends to be more sensitive to the Fed’s interest
rate moves, is knocking on the door of 1%, up 24 basis points so far this year, FactSet data show.

But do interest rate increases translate into a weaker stock market?

As it turns out, during so-called rate-hike cycles, which we seem set to enter into as early as
March, the market tends to perform strongly, not poorly.

In fact, during a Fed rate-hike period the average return for the Dow Jones Industrial Average
DJIA is nearly 55%, that of the S&P 500 SPX is a gain of 62.9% and the Nasdaq Composite
COMP has averaged a positive return of 102.7%, according to Dow Jones, using data going back
to 1989 (see attached table). Fed interest rate cuts, perhaps unsurprisingly, also yield strong
gains, with the Dow up 23%, the S&P 500 gaining 21% and the Nasdaq rising 32%, on average
during a period of Fed rate cuts.
Dow Jones Market Data

Interest rate cuts tend to occur during periods when the economy is weak and rate hikes when the
economy is viewed as too hot by some measure, which may account for the disparity in stock
market performance during periods when interest-rate reductions occur.

To be sure, it is harder to see the market producing outperformance during a period in which the
economy experiences 1970s-style inflation. Right now, it feels unlikely that bullish investors will
get a whiff of double-digit returns based on the way stocks are shaping up so far in 2022. The
Dow is down 1.2%, the S&P 500 is off 2.2%, while the Nasdaq Composite is down a whopping
4.8% thus far in January.

Read: Worried about a bubble? Why you should overweight U.S. equities this year, according to
Goldman
What’s working?

So far this year, winning stock market trades have been in energy, with the S&P 500’s energy
sector XX:SP500 XLE looking at a 16.4% advance so far in 2022, while financials XX:SP500
XLF are running a distant second, up 4.4%. The other nine sectors of the S&P 500 are either flat
or lower.

Meanwhile, value themes are making a more pronounced comeback, eking out a 0.1% weekly
gain last week, as measured by the iShares S&P 500 Value ETF IVE, but month to date the
return is 1.2%.

See: These 3 ETFs let you play the hot semiconductor sector, where Nvidia, Micron, AMD and
others are growing sales rapidly
What’s not working?

Growth factors are getting hammered thus far as bond yields rise because a rapid rise in yields
makes their future cash flows less valuable. Higher interest rates also hinder technology
companies’ ability to fund stock buy backs. The popular iShares S&P 500 Growth ETF IVW is
down 0.6% on the week and down 5.1% in January so far.

What’s really not working?

Biotech stocks are getting shellacked, with the iShares Biotechnology ETF IBB down 1.1% on
the week and 9% on the month so far.

And a popular retail-oriented ETF, the SPDR S&P Retail ETF XRT tumbled 4.1% last week,
contributing to a 7.4% decline in the month to date.

And Cathie Wood’s flagship ARK Innovation ETF ARKK finished the week down nearly 5%
for a 15.2% decline in the first two weeks of January. Other funds in the complex, including
ARK Genomic Revolution ETF ARKG and ARK Fintech Innovation ETF ARKF are similarly
woebegone.

And popular meme names also are getting hammered, with GameStop Corp. GME down 17%
last week and off over 21% in January, while AMC Entertainment Holdings AMC sank nearly
11% on the week and more than 24% in the month to date.
Gray swan?

MarketWatch’s Bill Watts writes that fears of a Russian invasion of Ukraine are on the rise, and
prompting analysts and traders to weigh the potential financial-market shock waves. Here’s what
his reporting says about geopolitical risk factors and their longer-term impact on markets.