With many calling for central banks around the world to start raising interest rates sometime in 2010, there is a general perception that this will pose a challenge for equity returns. While stocks typically post solid gains in the period leading up to rate hikes in the United States, markets tend to register only modest performance in the year following the first Fed tightening.
UBS looked at eight examples and found that leading up to the interest rate increase, stocks rose an average of roughly 16%. In every case, equity returns in the 12 months following a rate hike were lower than in the previous year. In two of the eight cycles, markets declined.
UBS economists forecast the Fed will begin to raise rates in late-June and the European Central Bank will lift rates in the third quarter. Meanwhile, the rate hike cycle has already begun in some places, with China just recently starting to tighten and Australia raising rates in 2009.
While cyclical sectors typically outperform in advance of interest rate increases, in the 12 months following a rate hike leadership is more mixed.
“A continued recovery in the global economy should keep equity markets around the world underpinned,” UBS strategists said in a report. “With Fed tightening still unlikely before late-Q2, our analysis supports forecasts from our regional strategy teams calling for additional market upside.”
UBS recommends investors trade up in quality, favouring companies with better fundamentals. The strategists also suggested a more balanced tilt between cyclicals and defensives than in 2009 for global strategies.