Asset Class Returns during Previous Fed Tightenings
The Federal Funds Rate is the interest rate at which institutions lend funds maintained at the Federal Reserve (“Fed”) to other institutions. The Fed Funds Rate is often looked at as a benchmark for other interest rates and has a profound influence on overall economic activity as its level can either help to stimulate the economy or control inflation pressures. The Fed’s Federal Open Market Committee (FOMC) sets targets for the Fed Funds Rate and looks to achieve these targets through their own open market operations. Following the market meltdown of 2008 – early 2009, the Fed adopted an accommodative stance by lowering interest rates, through various operations including quantitative easing, to historic lows with an overarching goal of stimulating the economy through less expensive sources of credit. Now that the economic recovery is getting to a point where the Fed believes that the U.S. economy may be able to stand on its own two legs, the Fed will be in a position to tighten (i.e. be less accommodative) by raising their Fed Funds target rate. This then begs the question as to which asset classes have historically fared better, from a total return perspective, when the Federal Funds rate was increased in previous years.
Dating back to 1979, the Fed has raised the Federal Funds Rate 44 times. There were 13 years over this timeframe where the Fed raised the Federal Funds Rate at least once. Different asset classes experienced different total return performances over this 13 year time period. While history should not be relied upon solely to make investment decisions, it is also important to not ignore history completely when formulating forward looking investment strategies.
Below we have provided total return histories for a few widely recognized equity, fixed income and alternative investment indexes for each of the 13 years in question. Based on this data alone, one might conclude that Real Estate Investment Trusts (“REITs”) and emerging market equities* should perform better, on a relative basis, than developed market equities and REITs, and emerging market equities* and developed market equities should perform better, on a relative basis, than bonds, in the upcoming rising interest rates environment that many are expecting.
With this said, prevailing interest rates clearly were not the only factor influencing the track records of these indices which led to several conflicting, relative results during the different calendar year periods that were part of our study .
# of Fed Funds
Total Return %
MSCI EAFE NR USD
Index2 Total Return %
NR USD Index3
Total Return %
Aggregate Bond Index4 Total Return %
Total Return %
Total # of Rate Increases
Average Annual Total Return over 13 year
Average Annual Total Return over 2004-2006
Data Source: Wells Fargo Advisors. Past performance is not an indication of future results. You cannot invest directly in an index. Figures referred are total return and include the impact of reinvested dividends.
1S&P 500 Index – Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
2 MSCI EAFE NR USD Index – The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. The Net Return is used which recognizes that the dividends are subject to tax and not received by the investor. Only the remaining portion of the dividend (net of tax) can be reinvested.
3MSCI EM NR USD Index – The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. The Net Return is used which recognizes that the dividends are subject to tax and not received by the investor. Only the remaining portion of the dividend (net of tax) can be reinvested.
4Barclays Aggregate Bond Index – The Barclays U.S. Aggregate Index represents the securities of the U.S. dollar-denominated, investment grade bond market. The Index provides a measure of the performance of the U.S. dollar-denominated, investment grade bond market, which includes investment grade (must be Baa3/ BBB-or higher using the middle rating of Moody’s Investor Service, Inc., Standard & Poor’s, and Fitch Rating) government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly offered for sale in the United States.
5Wilshire REIT Index – The Wilshire REIT Index measures U.S. publicly traded Real Estate Investment Trusts. The Wilshire U.S. REIT Index (WILREIT) is a subset of the Wilshire U.S. Real Estate Securities Index (WILRESI).
We believe that once the Fed’s unemployment and GDP growth targets are hit (likely not until the second half of 2014 at the earliest – though they could conceivably be hit earlier), the Fed is likely to use the 2004-2006 timeframe as a blueprint for their tightening program this time around. During this period, the Federal Funds Rate was gradually raised on 17 different occasions over a three year time period – specifically from July 2004 – June 2006, in equal increments of 25 Basis Points (i.e. 0.25%) each time. Throughout this cycle, here are the rankings of the average annual returns for the asset class associated with each index included in this study:
- Emerging Market Equities
- Developed Market (non-U.S.) Equities
- U.S. Equities
- U.S. Bonds
We are not suggesting that investors deviate from their longer term investment objectives, tolerance for risk or investment timeframes by abandoning diversified portfolio strategies and concentrating on certain asset classes for the reasons cited above. To the contrary, we, at Hennion & Walsh, still contend that asset allocation remains of the upmost importance and should always be constructed in accordance with one’s investment objectives, investment timeframe and tolerance for risk. While past performance cannot guarantee future results, and asset allocation cannot ensure a profit or protect against a loss, applying a historical perspective (such as the one presented in our study) and applying, or maintaining, an appropriate strategic asset allocation can help provide comfort and direction to investors during periods of great volatility and/or uncertainty.
*Emerging markets equity conclusions based on a limited amount of historical data available for the MSCI EM USD Index where total return information was not available for the years 1979, 1980, 1981, 1987, 1988, 1989, 1994 and 1995.