Concerns of higher interest rates are on investors' minds today as Federal Reserve Chairman Ben Bernanke gives his semiannual economic report to Congress. The testimony comes less than a week after the Fed raised the discount rate that it charges banks to borrow, sparking speculation about when it might finally start boosting its more critical fed funds rate.
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Investors probably don't need fresh worries of any kind after seeing stocks struggle for the past month, including Tuesday, when the Dow Jones industrials fell 101 points to 10,282 on disappointing consumer confidence.
Rod Smyth of Riverfront Investment says investors should accept that the "era of the completely free lunch" with extremely low interest rates is over, and now "it's not a question of if, but when" the Fed takes up the fed funds rate.
But that's not necessarily bad for stocks because:
•History is kinder than widely believed. Investors assume interest rate increases are poison to stocks, but that's not completely true. The Fed has boosted rates 13 times since 1946, says Sam Stovall of Standard & Poor's. And on average, the S&P 500 rose 2.6% and 6.2% the following six and 12 months, respectively. However, those six- and 12-month returns after rate moves lag behind the long-term average for those periods of 4% and 8.1%, S&P says.
•Rationale for increases is actually a positive. The Fed's boost of the discount rate merely takes away life-support for banks, but it doesn't directly change stimulus for the economy, Smyth says. The Fed is not "trying to achieve anything bad," he says, just gradually testing the water. Investors should pay more attention to long-term rates, which the Fed doesn't set directly, he says. The yield on the 10-year Treasury fell Tuesday to 3.7% from 3.8%.
•Increases aren't worrisome until they're near the end. Worrying about higher rates now is premature, says James Paulsen of Wells Capital. S&P doesn't expect the fed funds rate to move higher until the third quarter. And even if the rate is boosted sooner, rate moves are more troubling after they've been ongoing, and there's the risk the Fed doesn't stop soon enough, he says. That's far away, since most rate-boosting periods go on for more than a year, S&P says. "The danger is the hike that could be the straw that breaks the camel's back," he says. "We're not even close to that."
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