Stocks erased their gains for the year on Tuesday.
Some analysts speculated investors were concerned about how the Federal Reserve’s interest rate hikes will impact stocks. The basic thinking is that the sooner rate hikes come, the more bearish it is of for stocks.
In a research note Monday, Deutsche Bank’s David Bianco suggested the S&P 500 could still have more room to decline given the increasing likelihood that the Fed will hike rates sooner than later.
Here’s Bianco: “Decent 4Q EPS (albeit weak guidance), ECB QE, and a still accommodative Fed pushed the S&P to 2100. But policy normalization risks remain, particularly for the dollar and long-term yields. We don’t see a quick recovery for oil prices. Strong job growth and falling unemployment despite still slow GDP suggests that Fed hikes are on the horizon and likely strengthen the dollar further. We see risk of
a near-term 5 -9% dip and reiterate the importance of sector preferences.“
While the impact on stocks’ price-to-earnings ratios will last “all year,” Bianco says this is how it’s played out in the past.
“Stocks typically sell-off on the first of a series of rate hikes, but the magnitude and duration of the sell-off depend on conditions,” Bianco said. “During early cycle hikes the initial sell-off was generally small, quickly recovered and further S&P gains came in next three months and longer (like 2004, 1983, 1972). But many sell-offs on late cycle hikes became corrections or even bear markets.”
He also included this chart, showing how various sectors perform when rates and yields rise.