The Best-Performing Asset Classes During Fed Tightening

Rising interest rates are typically seen as a bad development for stocks. While it’s true that higher interest rates eventually tend to slow growth and drive cash from stocks to fixed income investments, the period leading up to the tipping point has historically been very good for stocks.

Bank of America Merrill Lynch recently took a look at how different asset classes respond during periods of Federal Reserve tightening.

Shrinking Sheet

The S&P 500 has gained ground during 90 percent of interest rate tightening cycles since 1950, including logging gains in each of the eight most recent periods, according to BofA. 

The current cycle is a bit unique in that the Fed is also planning to withdraw $1.4 trillion in reserves over the next four years. There is plenty of historical context for this type of balance sheet shrinkage.

BofA found three prevailing trends in asset performance during past periods of Fed balance sheet shrinkage:

• Stocks have historically performed better than bonds during these stretches.
• Large-cap stocks have outperformed small-cap stocks.
• Value stocks have outperformed growth stocks.

The third trend is particularly noteworthy for traders given that growth stocks have significantly outperformed value stocks throughout the current bull market.

The Historical Context

Here’s a breakdown of the median returns in several different asset classes during periods of Fed tightening since 1929:

• Large-cap value stocks: 12 percent.
• Value stocks: 11 percent.
• Growth stocks: 11 percent.
• Large-cap growth stocks: 10 percent.
• S&P 500 index: 10 percent.
• Small-cap stocks: 8 percent.
• Long-term government bonds: 6 percent.
• Corporate bonds: 6 percent.
• WTI crude oil: 2 percent.
• 3-month Treasury bills: 2 percent.
• Gold: zero percent. 

How To Play It

The good news for investors is that no single asset class included tends to decline during these tightening periods, meaning Fed tightening and rising interest rates are not necessarily sell signals. Yet investors looking to maximize their gains based on historical performance should consider increasing their allocations to large-cap growth stocks and steering clear of commodities such as gold and oil.

One of the most popular large-cap value ETFs is the iShares Russell 1000 Value Index (ETF) IWD.

Related Links:

The Best Performing Sectors, Assets In The First Half Of 2018

A 2018 Midyear Update: The 10 Worst-Performing S&P 500 Stocks

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