The Federal Reserve has effectively promised the nation another 1.5% - 2% in short-term interest rate hikes. How will this likely affect equity (stock markets)? Below, I have charted the Federal Reserve’s short-term interest rates (in red) versus the ratio of the Nasdaq Index to the S&P Index between 1985 and 2022. Growth companies such as Facebook (FB) and Google (GOOG) with earnings in more distant years, are more likely to suffer differentially since those far off earnings are worth less with higher interest rates resulting from higher inflation.
Note that in September 2007, three months before the beginning of the Great Recession, the Federal Reserve’s short-term interest rate was 5.4% and the ratio of the Nasdaq to the S&P was 1.73. As the recession ensued, Fed rates declined to 0.2% and the ratio of indices climbed to 1.98. As rates moved even lower, the ratio rose to 2.40 in September 2016.
Over the full period, the correlation coefficient was a strong -0.62, indicating that as short-term interest rates fall, the ratio of the Nasdaq Index to the S&P rises. With the Federal Reserve slated to increase short-term interest rates by as much as two to three percentage points, this ratio should drop dramatically. This analysis does not encourage buying either, but if you just gotta buy—buy the S&P Exchange Traded Fund (SPY), not the Nasdaq ETF (QQQ).
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