Stock Rally Just Getting Started Before Rates Rise (Update1) By Alexis Xydias
Nov. 9 (Bloomberg) -- Stocks around the world are falling at the fastest rate since the worst of the credit crisis on concern central banks will start raising rates, a signal that triggered the biggest rallies over the past three decades. Benchmark indexes from New York to Tokyo to Frankfurt have lost an average of 4.4 percent since Oct. 19 on speculation policy makers will curtail stimulus measures before the global economy revives. History shows stocks have climbed 92 percent of the time in the six months before government borrowing costs began the biggest increases, data compiled by Bloomberg show. Federated Investors Inc., Renaissance Financial Corp. and Citigroup Inc. say investors may miss out on more gains after $12 trillion in spending by governments worldwide pushed the MSCI World Index up 65 percent since March. Shares rise before central banks push up interest rates because markets anticipate economic expansion first, says Linda Duessel, Federated's Pittsburgh-based equity strategist. "You should buy stocks now," said Duessel, who helps manage $400 billion. "There's an idea that they're taking away the punch bowl by indicating they're raising interest rates. But you can still get a decent rally after that." The S&P 500 rose an average 8.4 percent in the six months before the last five increases in the Fed's target rate for overnight loans between banks and added another 82 percent in the bull markets that followed, Bloomberg data show. Germany's DAX Index climbed 9 percent half a year before rates rose since 1988, while Japan's Nikkei 225 Stock Average posted a return of 8.3 percent in data going back to 1973. Bernanke Bets U.S. Federal Reserve Chairman Ben S. Bernanke may start to increase borrowing costs in June, according to Fed funds futures prices compiled by Bloomberg. Traders assign a 54 percent chance of an increase to at least 0.5 percent at the end of the Federal Open Market Committee's meeting on June 23, when the American economy is forecast to be in its fourth straight quarter of expansion, according to estimates compiled by Bloomberg. "You absolutely want to front-run the Fed," said Douglas Ciocca, who helps oversee $1.7 billion as the managing director at Renaissance in Leawood, Kansas, and recommended corporate bonds in November 2008 before they rallied 30 percent, according to Merrill Lynch & Co. indexes. "If I'm an investor and I see that there's a small progression toward stimulus extraction, it says to me that the economy is being re-established on a much firmer footing, and that's very positive." `Exceptionally Low' The S&P 500 has declined 2.6 percent since reaching a one- year high on Oct. 19 as reports on new home sales and consumer confidence trailed forecasts. The MSCI World Index of 23 developed country markets has slipped 3.1 percent. Both gauges rebounded last week after the Fed said it will keep rates "exceptionally low" for an "extended period." The steepest advance in U.S. stocks since the Great Depression is fading as investors speculate that more spending will be needed to maintain the pace of growth. The S&P 500 posted its first monthly retreat since February last month. Futures on the gauge added 0.3 percent today to 1,068.90. European Central Bank President Jean-Claude Trichet said Nov. 5 that he will withdraw some of the emergency measures aimed at ending the credit crisis and the Bank of England slowed the pace of bond purchases. A day earlier, the Fed outlined the circumstances in which it would be prepared to raise interest rates. First Mover Australia's S&P/ASX 200 Index has risen 1.8 percent since the country became the first in the so-called Group of 20 nations to boost rates. The Reserve Bank of Australia increased the overnight cash rate target on Oct. 6 to 3.25 percent from a 49-year-low of 3 percent amid signs the government's policies are helping contain unemployment. While last week's FOMC statement said "economic activity has continued to pick up," investors will become convinced when policy makers take action, said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York. "It would mean that the Fed feels comfortable that the economy as well as the financial system is strong enough to withstand higher interest rates," Pollack said. "That would be a positive for the equity markets." The severity of the credit crisis may prevent equities from rallying this time, said Toby Nangle, director of asset allocation research at Baring Asset Management in London, which oversees $45 billion. More than $1.6 trillion of global bank losses over the last two years sent the S&P 500 down 38 percent in 2008, the steepest drop since the Great Depression, and $15 trillion has been wiped out from stock market value since October 2007, according to data compiled by Bloomberg. Disappointing Reports While the U.S. economy grew a faster-than-expected 3.5 percent in the third quarter, reports in the past month have heightened investor concern that the recovery will be uneven. Americans cut spending for the first time in five months and new home sales dropped in September. U.K. gross domestic product unexpectedly contracted 0.4 percent in the third quarter, the government said Oct. 23. The Bank of Japan kept its benchmark interest rate at 0.1 percent on Oct. 30 after consumer prices fell at a near-record pace in September. "If central banks were to tighten, it would starve off the oxygen," said Nangle. "To remove the accommodation, while it may be prudent, it would undermine equity markets." `Out of Steam' The global economy's recovery may "run out of steam" and another recession might follow in 2010 or 2011, billionaire hedge fund manager George Soros, 79, said at a conference on Oct. 30. Jeremy Grantham, the chief investment strategist at Boston- based Grantham Mayo Van Otterloo & Co., wrote in a letter to investors last month that the rally will end and that "fair value" for the S&P 500 is around 860, or 20 percent below its level at the end of last week. "My guess, though, is that the U.S. market will drop below fair value" before 2010 is over, said Grantham, 71. "Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits." Signs the economy is growing enough to warrant higher interest rates may extend the S&P 500's 58 percent rally since March, according to Michala Marcussen, head of strategy and economic research at Societe Generale Asset Management, which oversees $406 billion. U.S. policy makers have pledged to hold rates near zero for an "extended period" for six straight meetings. Fed Signals "What the Fed is really telling us by not changing the rhetoric is, `We are still worried about the credit channels,'" said Paris-based Marcussen. "We had a nice, strong rally. What's going to drive us from here? Maybe now the markets are waiting for the Fed." Investors should buy stocks before rates rise, wrote Tobias Levkovich, a New York-based strategist at Citigroup, in an Oct. 28 report to clients. Since 1915, the S&P 500 climbed in 25 of the 38 years when the benchmark U.S. discount rate increased. Energy, information technology, industrial and commodity stocks tend to outperform just before the Fed tightens policy, he said. Economists forecast the Fed funds rate will rise to 0.5 percent in the second quarter of 2010, according to a survey of 63 financial companies by Bloomberg last month. The rate will climb by a quarter percentage point every quarter through the first three months of 2011, the projections show. The DAX gained 7.6 percent in the six months before the Bundesbank raised rates in June 1988, and climbed 3.4 percent and 16 percent before increases by the European Central Bank in 1999 and 2005. Japan's Nikkei 225 advanced between 5.4 percent and 21 percent in the six months prior to three increases from 1973 to 1989. The benchmark measure dropped 8.2 percent in the run-up to the July 2006 boost that followed a decade of deflation. "There seems to be a common misperception among investors that when interest rates rise, stock prices necessarily fall," Levkovich wrote. "We do not believe a rising Fed funds rate is necessarily as bad for the equity markets."
