The Federal Reserve’s recent decision to begin raising interest rates stands in contrast to many other central banks around the world, which are keeping their baseline interest rates flat or lowering them.
So, does this divergence of central-bank policies spell good or bad news for investors holding U.S. stocks? Looking at data on how leading stock indexes around the world have behaved in similar circumstances suggests U.S. shares should fare relatively well.
To explore the effects of divergent central-banking policies on U.S. stocks, with the help of two research assistants, Georgi Minov and Cameron Hair, I collected historical interest-rate and stock-return data from around the world going back 40 years.
We first looked at whether each nation’s central bank was raising its interest rate, lowering it or keeping it the same over time. Next, we looked at stock-return data over the same periods for the largest industrialized economies with defined indexes—the U.S. (S&P 500), Germany (DAX), France (CAC 40), Canada (TSX), U.K. (FTSE) and Japan (Nikkei).
Using this data, we can compare the performance of U.S. stocks with that of foreign stocks during different interest-rate environments: all rates rising, all falling, or mixed. For each type of period, we explored how the S&P 500 did on an absolute basis (raw S&P 500 returns) and in comparison to the foreign indexes as a group (S&P 500 return minus the foreign-index return) based on monthly averages during the periods defined by the interest-rate policies at the time.
The first interesting finding is that it really is the synchronization of interest-rate policies that provides the most extreme results.
When the world’s central banks are moving their interest rates down, we see the S&P 500 outperform the average of the foreign indexes by the most—0.55 percentage point a month (with an absolute return of 0.43% a month for the U.S. stocks). This could be due to so-called flights to safety—when central banks around the world are cutting interest rates (e.g., during the dot-com crash, the recession of 2008 and the most recent pandemic), investors from around the world leave their host country’s markets and head to the U.S.
Divergent
Average monthly return for the S&P 500 during different interest-rate environments*.
Average monthly return for the S&P 500 minus the corresponding foreign national index during different interest-rate environments*.
Foreign nation’s interest rates
Foreign nation’s interest rates
Average monthly return for the S&P 500 during different interest-rate environments*.
Average monthly return for the S&P 500 minus the corresponding foreign national index during different interest-rate environments*.
Foreign nation’s interest rates
Foreign nation’s interest rates
Average monthly return for the S&P 500 during different interest-rate environments*.
Average monthly return for the S&P 500 minus the corresponding foreign national index during different interest-rate environments*.
Foreign nation’s interest rates
Foreign nation’s interest rates
Average monthly return for the S&P 500 during different interest-rate environments*.
Foreign nation’s interest rates
Average monthly return for the S&P 500 minus the corresponding foreign national index during different interest-rate environments*.
Foreign nation’s interest rates
Average monthly return for the S&P 500 during different interest-rate environments*.
Foreign nation’s interest rates
Average monthly return for the S&P 500 minus the corresponding foreign national index during different interest-rate environments*.
Foreign nation’s interest rates
By contrast, when the world is moving interest rates up, we see the S&P 500 underperform the most—by 0.44 percentage point a month compared with the foreign-index average. (The average absolute return a month for U.S. stocks in such periods is 0.63%.) This is possibly due to investors from around the world moving their money back home, since rising interest rates usually happen in good economic times.
How about for our current interest-rate environment—with the U.S. raising its rate and the rest of the world mostly keeping rates flat? On average when this has occurred over the past 40 years, the S&P 500 has delivered an absolute return of 0.45% a month (which amounts to 5.53% over a 12-month period). In comparison with the foreign indexes, meanwhile, the S&P during such periods has delivered an outperformance of 0.02 percentage point a month (0.26 percentage point over a 12-month period).
And the best-case scenario: If the U.S. keeps raising interest rates while other central banks reverse course and begin to lower interest rates, our data tell us, the S&P 500 turns in an absolute monthly return of 0.54 percentage point, and outperforms the monthly average for foreign indexes by an average of 0.40 percentage point, or an annualized difference of 4.90 percentage points over a 12-month period.
Dr. Horstmeyer is a professor of finance at George Mason University’s Business School in Fairfax, Va. He can be reached at reports@wsj.com.
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