Quick Bite | If interest rates are peaking, what investments are likely to do best?

By the time you read this, the RBA will have raised official cash rates by 25 basis points, from 4.1% to 4.35%. While there are no guarantees that this will be the last rate rise, we suggest that it is the right time to consider which investments do best once rates have peaked. The data and information below is sourced from studies of the US market and the Wall Street Journal (WSJ).

The simple answer to my opening question about which asset class does best once rates peak is of course equities. But where should one focus? What kind of stocks?

Source: WSJ


The primary finding of the George Mason University study is that all stocks do well when interest rates first reach their peak, but they don’t do nearly as well during the second half of a plateau. The first half of an interest-rate peak has historically been where investors can get the best returns, with returns falling off sharply during the second half.

While all stocks do well, small-caps and growth companies are the types of shares that fare best during periods when rates peak and then plateau. But there is a caveat – most of the benefits accrue during the first half of the plateau. So you have to be quick!

The study referred to analysed data going back 50 years for various asset classes and subclasses, including US large caps, small caps, growth stocks, value stocks and real-estate investment trusts, as well as emerging-market stocks, international stocks, money market instruments and fixed income. It then isolated six peak-and-plateau occurrences over the 50-year period where the US Federal Reserve stopped raising rates and kept rates steady for three months or more.

Take large caps. The average large-cap stock in the S&P 500 returned 21.4% annualised during the first half of rate plateaus compared with 6.9% during the back end. To put these numbers into context, the average annualised returns for US large caps was 12.5% over the 50-year period.

When we look at small-caps and growth stocks, we see even better returns during the first half of rate plateaus. For small caps, the average annualised return is 27.6%, and for growth stocks, it is 26.3%. Those returns cool off in the second half of plateaus for both asset classes – averaging 3.5% and 10.2%, respectively.

While Australia and the US are very different economies and their sharemarkets are quite distinct, we tend to find that the Australian market often takes its lead from the US, and so if rates are at their peak and we don’t experience any major negative surprises, it may be worthwhile paying close attention to this analysis.



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