With the back and forth in the financial media about whether the Fed should or will raise interest rates in the coming quarter, it is not surprising that stock pickers and speculators are weighing in with their ideas of what investors should do in the event that a rate hike happens. In the following article provided by Dimensional Fund Advisors we examine the history of stock and bond response to interest rate hikes and we, not so surprisingly, see that it impossible to predict and therefore, should not be used to make portfolio or investment decisions. Like most other hot news topics, the rate hike is just fodder to sell whatever the next big thing is. My advice, tune out the noise and keep your eye on the long game. 

When Rates Go Up, Do Stocks Go Down?

DIMENSIONAL FUND ADVISORS | JUNE 2017

Should stock investors worry about changes in interest rates? Research shows that, like stock prices, changes in interest rates and bond prices are largely unpredictable.¹ It follows that an investment strategy based upon attempting to exploit these sorts of changes isn’t likely to be a fruitful endeavor. Despite the unpredictable nature of interest rate changes, investors may still be curious about what might happen to stocks if interest rates go up.

Trivia time: how many stocks make up the Wilshire 5000
Total Market Index (a widely used benchmark for the US equity market)?

While the logical guess might be 5,000, as of December 31, 2016, the index actually contained around 3,600 names. In fact, the last time this index contained 5,000 or more companies was at the end of 2005. This mirrors the overall trend in the US stock market. In the past two decades there has been a decline in the number of US-listed, publicly traded companies. Should investors in public markets be worried about this change? Does this mean there is a material risk of being unable to achieve an adequate level of diversification for stock investors? We believe the answer to both is no. When viewed through a global lens, a different story begins to emerge—one with important implications for how to structure a well-diversified investment portfolio.

U.S. AGAINST THE WORLD

When looked at globally, the number of publicly listed companies has not declined. In fact, the number of firms listed on US, non-US developed, and emerging markets exchanges has increased from about 23,000 in 1995 to 33,000 at the end of 2016. (See Exhibit 1.)

Ever ridden in a car with worn-out shock absorbers? Every bump is jarring, every corner stomach-churning, and every red light an excuse to assume the brace position. Owning an undiversified portfolio can trigger similar reactions.

In a motor vehicle, the suspension system keeps the tires in contact with the road and provides a smooth ride for passengers by offsetting the forces of gravity, propulsion, and inertia.

You can drive a car with a broken suspension system, but it will be an extremely uncomfortable ride and the vehicle will be much harder to control, particularly in difficult conditions. Throw in the risk of a breakdown or running off the road altogether and there’s a real chance you may not reach your destination.

In the world of investment, a similarly bumpy and unpredictable ride can await those with concentrated and undiversified portfolios or those who constantly tinker with their allocation based on a short-term rough patch in the markets.

Global equity markets advanced in December with a 2.25% aggregate return. Developed (ex US) markets (+3.23%) outperformed US markets (+1.96%) and Emerging markets (+0.35%).

In the US, small cap (+2.52%) outperformed large cap (+2.19%) and mid cap (+0.93%). Among price‐to‐book asset classes, value (+3.93%) beat neutral (+1.11%) and growth (+0.83%). Telecommunication Services (+8.11%) posted the largest return and Financials (+4.22%) made the largest contribution. Materials (‐0.65%) fell the most and was the largest detractor for the month.