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How Asset Classes Have Performed After Interest Rate Hikes

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How to use: Arrows on side navigate between annualized return and annualized risk

Annualized returns for various asset classes during the last three periods of interest rate hikes, organized from lowest average return to highest average return.
Annualized risk for various asset classes during the last three periods of interest rate hikes, organized from lowest average risk to highest average risk.
Interest Rate Hikes_Asset Class Returns
Interest Rate Hikes_Asset Class Risk
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Preview image showing annualized returns for various asset classes during the last three periods of interest rate hikes, organized from lowest average return to highest average return

This infographic is available as a poster.

Asset Class Performance After Interest Rate Hikes

For the first time in more than three years, the U.S. Federal Reserve has raised the target interest rate. It’s an incremental step towards fighting inflation that is at its highest level in 40 years. Not only that, the Federal Reserve is predicting six more interest rate hikes before the end of 2022.

What does this mean for investors and their portfolios? In this Markets in a Minute from New York Life Investments, we show the risk and return of select asset classes during the last three periods of interest rate hikes.

Historical Returns After Interest Rate Hikes

We looked at annualized returns, which measures the return investors would have earned in a year if returns were compounded. Here is how they break down, sorted from lowest average return to highest average return.

Asset ClassJun. 1999–
Jun. 2000
Jun. 2004–
Jul. 2006
Dec. 2015–
Jan. 2019
Average
Municipal Bonds1.6%4.9%2.7%3.1%
Short-Term Bonds5.4%2.9%1.1%3.1%
Long-Term Bonds5.1%5.6%2.7%4.5%
High-Yield Bonds-1.1%8.4%7.5%4.9%
Bank Loans4.2%5.9%5.2%5.1%
Large-Cap Value Stocks-1.4%12.6%9.1%6.8%
Large-Cap Stocks12.1%8.1%10.9%10.4%
REITs-0.6%24.4%8.4%10.8%
Gold6.7%24.5%7.2%12.8%
Large-Cap Growth Stocks24.7%3.8%12.3%13.6%
Ex-U.S. Developed Country Stocks21.6%21.5%5.5%16.2%
Global Commodities63.1%14.3%0.3%25.9%

Based on time periods from the first Federal Reserve rate hike until one month after the last rate hike, which, on average, is when the effective federal funds rate tends to stabilize.

Among fixed income investments, floating rate bank loans had the highest average return. These loans pay a spread over a specified reference rate, with the rate resetting every 30, 60, or 90 days based on the prevailing interest rate. Because the rate “floats”, payments can rise as interest rates rise. However, bank loans are made to non-investment-grade companies, which are considered to be higher risk.

Ex-U.S. developed country stocks had the highest average return of the select stock types. International stocks may be a hedge against interest rate hikes because, compared to U.S. large cap stocks, they are more heavily concentrated in cyclical sectors like materials, industrials, and financials. These sectors tend to perform well when the economy is growing and rates are rising.

Within the alternatives realm, global commodities were the strongest on average. The average is skewed upward because of the outsized return earned in the 1999–2000 period. Brazil, Russia, India, and China were rapidly industrializing, which required an enormous amount of raw materials, food, and energy commodities. The boom lasted for more than 10 years in what is known as a commodity super cycle.

The Other Side of the Coin: Risk

We also measured asset class risk using standard deviation, which looks at the amount of variation in returns. Here is how it breaks down over the last three periods of interest rate hikes, organized from lowest to highest average risk.

Asset ClassJun. 1999–
Jun. 2000
Jun. 2004–
Jul. 2006
Dec. 2015–
Jan. 2019
Average
Short-Term Bonds0.2%0.4%0.2%0.3%
Bank Loans1.9%0.7%3.0%1.9%
Municipal Bonds4.4%2.7%3.3%3.5%
High-Yield Bonds3.9%4.0%5.4%4.4%
Long-Term Bonds5.5%7.2%9.4%7.4%
Large Cap Stocks16.0%7.4%11.5%11.6%
Large-Cap Value Stocks16.3%7.2%11.8%11.8%
Ex-U.S. Developed Country Stocks14.4%10.6%11.8%12.2%
REITs10.9%13.6%13.8%12.7%
Large-Cap Growth Stocks19.4%8.0%12.2%13.2%
Gold20.0%15.6%12.9%16.2%
Global Commodities15.1%23.9%16.7%18.6%

Short-term bonds had the lowest risk, and were 25 times less risky than long-term bonds on average. Bonds with shorter maturities have a lower duration—which measures the sensitivity of a bond’s price to interest rate changes—than long-term bonds. This means their prices do not drop as much when rates rise.

Among the select stocks, large cap stocks and their value style counterparts had the lowest average risk. Value stocks tend to be established companies with actual earnings, meaning they can raise prices to boost profit margins during interest rate hikes and rising inflation.

Within the alternatives realm, real estate investment trusts (REITs) had the lowest risk. Rising rates generally means the economy is growing, which translates into greater demand for real estate and the ability to charge higher rent. Interestingly, a 40-year analysis by Nareit found that REITs performed well during both high inflation and low inflation periods. This means they are less subject to prediction risk, or the risk that investors correctly predict high-inflation periods. In contrast, commodities performed well during high inflation periods but performed poorly during low inflation.

Interest Rate Hikes and Your Investments

In addition to considering the historical returns of asset classes during interest rate hikes, investors may also consider the potential risk involved.

We looked at performance within the broader categories of fixed income, stocks, and alternatives. Historically, bank loans, ex-U.S. developed country stocks, and global commodities have offered the highest average returns. However, short-term bonds, large cap stocks, and REITs had the lowest average risk.

The current macroeconomic environment, such as the Russia-Ukraine conflict, may also play a role in performance. Will history repeat itself, or will different asset classes outperform during the interest rate hikes to come?

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Markets in a Minute

Identifying Trends With the Relative Strength Index

When is the S&P 500 Index considered overbought or oversold? The relative strength index may offer some answers to identifying market trends.

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Identifying Market Trends: The Relative Strength Index

What happens when the S&P 500 Index enters oversold territory? Does the market reverse, or continue on this trend?

A widely-used momentum indicator, the relative strength index (RSI) may offer some insight. The RSI is an indicator that may show when a stock or index is overbought or oversold during a specific period of time, indicating a potential buying opportunity.

This Markets in a Minute from New York Life Investments looks at the RSI of the S&P 500 Index over the last three decades to show how the market performed after different periods of overbought or oversold conditions

What is the Relative Strength Index?

The RSI measures the scale of price movements of a stock or index. In short, the RSI is used to calculate the average gains of a stock divided by the average losses over a certain time period. These are then tracked across a scale of 0 to 100. Broadly speaking, a stock is considered overbought if it reads 70 or above and it is considered oversold if it is 30 or below.

For example, when the S&P 500 Index has a RSI of 85, an investor may consider it overbought and sell their shares. Conversely, if the RSI hits 25, an investor may buy the S&P 500 thinking the market will bounce back.

The RSI is often used with other indicators to identify market trends.

The Relative Strength Index and S&P 500 Returns

Below, we show the 12-month returns of the S&P 500 Index after key ‘overbought’ or ‘oversold’ conditions in the market as indicated by the RSI:

DateRSIShiller PE Ratio*S&P 500 Index 12-Month Return
Jul 15 200220239.4%
Dec 4 200673274.5%
Oct 13 200815167.3%
Feb 7 201175231.9%
May 13 2013752316.1%
Jan 8 20188933-7.2%
Mar 16 2020222566.3%
May 3 202172370.0%

*Measured by the average inflation-adjusted earnings of the S&P over 10 years

As the above table shows, following each period of extremely oversold territory in the RSI, the S&P 500 Index had positive returns.

In fact, the S&P 500 Index had the strongest one-year returns following the COVID-19 crisis of March 2020, with over 66% 12-month returns. During the time of extreme fear, the RSI sank to deeply oversold territory before sharply rebounding.

Interestingly, following periods of extremely overbought conditions in the market there was a range of positive and negative performance. Most recently, before the peak of the last cycle in 2021, the S&P 500 Index spent roughly 9 months in ‘overbought’ territory before declining into 2022.

The Relative Strength Index in 2022

With the economy in uncertain territory, how does the RSI look today?

In early June, following a bleak consumer sentiment announcement, the RSI fell to 30, hovering on oversold territory. Since then, it has risen closer to 40 as consumer sentiment and perspectives on economic conditions have slightly improved.

However, whether or not the RSI will continue on this uptrend remains to be seen.

For the remainder of 2022, market sentiment, which may be shaped by the coming GDP and inflation figures, could push RSI into oversold territory once again. As a bright spot this may be good news—reinforcing a turning point in the market.

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Markets in a Minute

Visualized: How Bonds Help Reduce Bear Market Risk

How have bonds historically performed during a bear market? How have different stock and bond allocations performed?

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Bear Market Risk

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Visualized: How Bonds Help Reduce Bear Market Risk

Which tactics can investors use to reduce portfolio downside risk?

One time-tested method is allocating to bonds. Bonds have sheltered portfolio losses during bear markets thanks to the lower risk profile of bonds compared to stocks. Often, when stocks declined during market selloffs, safer assets like bonds tended to increase as the demand for stability grew.

This Markets in a Minute from New York Life Investments shows the performance of bonds and stocks during bear markets since World War II.

Bond Performance During Bear Markets

Bear markets are defined as a 20% or more decline in U.S. large cap stocks from peak to trough. Since World War II, bear markets have occurred less frequently than bull markets, with the U.S. stock market spending 29% in a bear market versus 71% in a bull market.

With this in mind, we show how a spectrum of portfolio asset allocations to stocks and bonds have performed over the last several bear markets.

  • Stocks: represented by U.S. large cap stocks
  • Bonds: represented by U.S. intermediate government bonds, which are issued with maturity dates between two and five years
Allocation (Stock / Bond)Average DrawdownAverage Time Until Recovery*
100% / 0%-34%3.3 years
90% / 10%-31%3.2 years
80% / 20%-28%2.9 years
70% / 30%-24%2.8 years
60% / 40%-20%2.5 years
50% / 50%-16%2.1 years
40% / 60%-11%1.2 years
30% / 70%-7%0.8 years
20% / 80%-4%0.8 years
10% / 90%-2%0.5 years
0% / 100%-1%0.2 years

*Length of time until new all-time high

For a 100% stock portfolio, the average drawdown was -34%, with 3.3 years until recovery—the time it took to reach a new all-time high.

Comparatively, a portfolio entirely made up of bonds fell -1% on average during bear markets with a recovery time of just a few months.

Balanced Portfolios in Bear Markets

Looking closer, we show how adding bonds to a portfolio has cushioned portfolio losses over the following market downturns, sometimes by as much as 20 percentage points.

Bear Market100% Stock Portfolio Max Drawdown60/40 Portfolio Max Drawdown
2020-20%-10%
2008-51%-30%
2001-45%-22%
1988-30%-17%
1973-43%-26%
1969-29%-18%
1962-22%-13%
1947-22%-13%

A balanced 60/40 portfolio had a 20% average drawdown, recovering in 2.5 years. During the 2020 COVID-19 crash, for instance, a 60/40 portfolio fell almost 10% and fully recovered in six months. By contrast, a 100% stock portfolio declined nearly 20%.

In all of the above historical downturns, investors with a diversified portfolio have been better positioned in a bear market.

Building Portfolio Strength

Bonds have historically seen less volatility than stocks during tougher financial conditions. Typically, riskier assets like stocks have been more prone to market fluctuations than bonds.

To prepare for a bear market, investors can structure a portfolio that aligns with their risk tolerance. Over the long run, the diversification benefits of bonds have been fundamental to protecting portfolios and lowering risk.

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